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.

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.

259-262

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.

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.

Pg 250-253

While Fischer Black continued working for Goldman Sachs, he noticed the computer could be used to automate trading. He also noticed that, even though the Value Line index in Kansas City was a geometric average, most people treated it as an arithmetic average, which overvalued futures. Black could buy stocks on the cheaper market while selling futures on the overpriced market as long as arbitrage existed. To speed up the process of analyzing this arbitrage and mass pricing of stocks and futures, he hired a civil engineer grad named Jeff Wecker from Princeton University to figure out the programming and math. Fischer also hired Wecker’s friend, Michael Dubno.

Because Goldman was the first to really use computers and automated trading, it was able to take advantage of arbitrage over and over again until the market forces balanced out and prices converged. By doing so, Fischer and his team made Goldman Sachs a lot of money.

Pages 245-250

Fischer Black was a workaholic at Goldman Sachs. Given that he was rarely seen outside of his office. In fact he had his office made sound proof so that he could not hear what was happening among the traders outside of his office. Fischer would spend hours on his computer typing notes and solving problems. He was tied to his computer and many times when he was on the phone or in an interview he would continue to type.
Fischer's job as the head of Quantitative Strategies required him to find ways for Goldman Sachs to make larger returns by market trading. Goldman Sachs quantitative trading strategies fell into two categories; technical and fundamental. Technical strategies focused on trends and patterns and fundamental strategies focused on company research that found under priced stocks. Both of these strategies Fischer thought created noise that traders became distracted by. Fischer worked to eliminate this noise by removing any books that contained that kind of information. He wanted traders to trade on skill and not luck.
In his work at Goldman Sachs he also noticed that the model that he had developed (The Black-Scholes model) had also created noise in the trading market. He noticed that using the model that options with low exercise prices were undervalued and higher priced options were overvalued and that the market was following the Black-Scholes model. To Fischer this provided an opportunity for higher returns. He taught his traders how the model could be used to analyze problems and make decisions.

Pages 240-245

In 1984, Goldman Sachs did both investment banking and trading. It had always been a great trading firm and even more after the acquisition of J. Aron Company. Unfortunately, relative to the profitability loss of this type of riskless arbitrage (commodities and currencies), the company wanted to shift toward more risky forms of arbitrage to reverse this tendency. For that reason, aware of the commercial value of the kind of analytical power that Fischer could bring to bear the trading side of the business, R. Rubin (founder of the Chicago Board Options Exchange, and user of the Black-Scholes Formula) hired Fischer. Indeed, Goldman Sachs had a culture that believes in intellectual firepower as its competitive advantage, and even though Fischer was unlikely to make a big contribution right away, R. Rubin was prepared to wait. There were two mains purposes for hiring Fischer. The first one was that he would help to apply financial theory all across the firm, to transform it into the premier investment-banking firm in the world. The second was that he would build analytical capacity in the Equities division in much the same way that Stanley Diller did in the Fixed Income one. Thus, Fischer had three careers: director of the Quantitative Group in the Equity division, member of the Management group in GSAM, and then member of the Fixed Income Research.

However, Fischer’s personal contribution to the firm brought mixed impressions and controversy. Although some resented to the fact he was enjoying an enviable position for no veritable reason, others while noting the lack of any direct contribution, were conscious of the indirect value of having his name on the firm’s roster (i.e. expansion to Japan, and Development of Price Theory talk). Moreover, for those running the firm, Fischer contributed to tremendous value, because by being the first “quant”, he truly helped the firm to build up a strong quant side of its operation. Finally, the quantitative finance style of Fischer gradually seeped into the general culture of the firm, despite his very unique personality. As pointed by M. Winkelman, Fischer as a puzzler was not using the money as a yardstick but had a different scale and never switched from it.

PG 236-240

Fischer’s new views and old views are quite opposite: the Fischer of old said “All traders, even those that lose money, help investors and society generally by helping to make securities correctly priced”; But the new Fischer said, “noise trading actually puts noise into prices.” The question is raised, why do noise traders trade at all? Fischer explains that noise traders think the noise is information, or they just enjoy trading.

Shefrin and Statman wrote a paper analyzing psychology and its applications to finance. Fischer reviewed their paper and loved it, calling it “brilliant”. This paper helped explain and answer questions, showing that investors make decisions for behavioral reasons rather than economical ones.

Information is costly in today’s finance world, especially good information. According to Fischer, equilibrium with costly information is still in equilibrium and is efficient, although others would say otherwise.

PG 235-236

(Jumping ahead a bit on the blog, some previous scheduled posts were not posted)

On the morning of December 30, 1985, as president of the American Finance Association, Fischer Black gave the yearly presidential address. What usually is a 45-minute speech, Black gave in 15 minutes and stunned the audience by what he said. His speech consisted of explaining how most of the time almost all markets are efficient, and distinguishing the difference between financial and economic efficiency. For much of Fischer’s career he had been arguing against what he said in his speech. People in the finance world were well aware of Fischer’s unorthodox views, and were surprised that he was beginning to see things from a wall-street point of view. However, Fischer had been thinking along these lines since 1982, before he entered the wall-street world.

Pgs 224-228

Following in Treynor's footsteps, Fischer had a deep interest in solving the problems of accounting. He found that an accountant and a financial analyst are essentially trying to achieve the same goal. That goal is to come up with some realistic measurement of firm value. The other discovery he made was that of all the accounting measures accountants use, aggregate earnings was the most highly correlated with market value. This showed Fischer that analysts and accountants were basically doing the same thing, just in two different ways. He published a paper titled "The Magic in Earnings" and began teaching accounting classes to further learn and investigate accounting's problems. The problem Fischer found with aggregate earnings as a measure of value was that some quarters could show negative earnings and it was not possible for a firm to have negative value. He solved this problem by simply viewing earnings as an option. By treating the firm's fixed costs as the strike price he could use option pricing to value earnings. This solved the negative earnings problem because options are always positively valued and this measure was even more correlated to market value than aggregate earnings.

Somethings Never Change

Some things change others never do. Fischer Black seems to be one of those things. After a long vacation, Fischer returned to the corporate world when he accepted a position at Goldman Sachs. The time away from the private sector was not misspent however. The research he had begun while at academia would help him as he consulted with one of the biggest financial institution in the world. During this time he had also been able to develop ideas and demonstrate his talents through different projects. In the end Goldman Sachs hired him. This came with an added benefit to his personal life as his father approved of his work in “real job.” His ex-wife was also overjoyed, as she received 40% of his salary. She found however that though his salary had changed, he really had not.

In the steps of his mentor

As Jack Treynor developed CAPM, he found a way to discount an uncertain set of cash flows back, for a single period, so a present value of a project could be calculated. The problem was that many firms look at projects across multiple periods. Fischer eventually found a way to discount cash flows back multiple periods, instead of the single periods CAPM allowed. His solution however was too complex for widespread application. A couple of years later he found a simpler way to solve the problem. Fischer’s approach was to have people develop a certain set of conditions and then discount t their projects based on those decisions. Fischer followed this discovery with a publication guiding people how to make practical decisions about the conditions that will prevail in the future.