Tuesday, April 26, 2011

It seems that near the end of his life, Black was increasing frustrated by the constant rejection he recieved from the economists community. He immediately seems to have assumed, that the rejection was due to a his failure to explain, what was so clear to him. To clear up any misunderstandings that may have existed, and to force people to take another look at his theory he finished the book he had been working on for a number of years. In his book he devoted much of his time addressing the problems that traditional economics could not explain, and even more room addressing what people had written about his ideas. As Black undertook such a large project he found that he had to explain not only the answers he set out to find, but to explain the impossibly complex model for economic growth.

Wednesday, April 20, 2011

Pages 274-279

According to Fischer, the crash was well within his broadened conception of equilibrium with costly information and noise trades. A couple of years later, Fischer (“the theorist”) would eventually team up with Bob Litterman (“the econometrician”) working out on the Black-Litterman asset allocation model. The idea was to blend the passive market portfolio with the active view portfolio based on ex ante expected deviation of performance from equilibrium, using the international CAPM to estimate the expected returns. Besides, the solution to blend the theoretical equilibrium allocations with the client’s view was to treat both as independent measures of an unknown parameter; each one measured subject to error, and then calculate the best combined estimate. The Goldman Sachs asset management adopted this model which was improved later on extending it to include equities and finding other uses such as running it backwards or either using it as a tool for risk control.

In 1994, Fischer had some health issues ,by the way, shifting his focus to sum up his life’s work.

Monday, April 18, 2011


Part of what got Black tenure at the University of Chicago and what got him a position as a partner at Goldman Sachs was his enjoyment of finding ways to take advantage of tax code. He wrote memos to his students and to his coworkers at Goldman about situations in which a non-tax-exempt and a tax-exempt investor could work together to ensure a mutual profit. At Goldman, he found a way in which Goldman could charge a fee for bringing the two parties together.

In addition to his professional success, Black now had himself a lady. He married Cathy Tawes, who had recently divorced from another partner at Goldman. Unfortunately, the book (in this section at least) does not go into details about the awkward scene at the meeting where the guy that Tawes just left and Fischer Black got into a fight over Cathy. Certainly a missed opportunity there.

Missed opportunities for literary gold notwithstanding, Fischer and Cathy were happy together. Unlike with his previous wife Mimi, their personalities fit just right so that he could continue to be a workaholic, and she wouldn't mind. She already had kids of her own, so all Fischer had to do was fit into the family.

PG 264-270

Goldman Sachs needed a better model of the embedded bond option, and valuing fixed income derivative products. This need was brought to Fischer’s attention, and he came up with the Black-Derman-Toy (BDT) computer model, which was later published in 1990. The BDT model worked much better than Black Scholes when it came to valuing bond options. Fischer was able to develop BDT quickly because he had been thinking about it since he attended Modigliani’s talk’s years ago. Modigliani expressed that the most important thing missing from an ideal pricing model was the implementation of risk and uncertainty.

Richard Roll was hired by Goldman Sachs to build a Mortgage Security Research capability within the Fixed Income Division; he tried to utilize CAPM to build the model. Years later, Roll and Fischer met and were able to analyze Roll’s empirical model and Fischer’s more theoretical BDT model. Fischer agreed that BDT had a few problems from the trader’s perspective, and portrayed an unrealistically high equilibrium. However, BDT worked well for firms to price custom options, and to calculate the correct hedge.

In a paper, Fischer explained the constant upward slope of the term structure can be clarified by viewing interest rates as options.

Pages 270-274

The Dow Jones Industrial Average dropped 508 points on October 19, 1987 which accounted for 22.6% of its value. Unlike others Fischer was excited on this day because it was history in the making. It gave him an opportunity to study and explain why the crash happened. Some people felt that the government needed to step in to help control the stock market so that there would not be this huge decrease again but Fischer felt that increasing government regulation would not help the market but would cause more problems by making it less liquid.
This section shows that Fischer was unconcerned about how much money or value was lost and was more concerned about explaining why it happened.
Fischer and Rob Jones worked at Goldman Sachs to develop a portfolio insurance, something that a firm by the name Leland, O'Brien, Rubinstein had developed to ensure that portfolios would not fall below a certain level. Fischer developed the constant proportion portfolio insurance which in his words was easier and better to use then the LOR.
Although Fischers constant proportion portfolio insurance was not implemented in time before the crash he was able to understand what factors influenced the crash. He concluded that the crash was a result of noise.

Pg. 153-158

When Fischer started at Goldman Sachs he first wanted to focus on eliminating the "noise" to improve their trading. He wanted to make sure there was no unnecessary information that would make trading more difficult. As Fischer did this he decided that there were two ways for a company to profit from trading in the long run. One was from taking advantage of intervention on the part of central banks, and the other was profit from "flow" trading. Flow trading happens when a trader is actively participating in a market, and then said trader uses his experience to anticipate price changes. From this theory he formed an idea of two types of traders, a "news" trader, and a "nice" trader. These types of traders end up being similar to the types of traders that a colleague of Fischer's created. Jack Treynor thought up the information based trader, and the value based trader. The information based trader takes advantage of inefficiencies in information, and the value based trader takes advantage of valuing inefficiencies. Both Fischer and Treynor came to the same conclusion that the central issue was the price, or value, of time. This lead to another theory on Fischer's part of what a market could look like in the future. His idea of a future market is one where there is an indexed limit order where there would be an urgency rate for each specific order. High urgency orders will cost more, encouraging more "slow" trading. Thus all securities and the price of time will have price schedules based on the urgency of the order.

Sunday, April 17, 2011

Pg 262-264

Even though the CAPM was always on Fischer’s mind, his expertise in option pricing provided more opportunities. However, the Markets started using Fischer Black’s CAPM model more so than he anticipated. When derivatives came to market, Black was not too impressed, initially. According to Black, derivatives were not necessary. Not until after he realized derivatives could be used to hedge real risk, he embraced the new idea and saw how it could fit in with his ideal CAPM world.