Pages 99-102

Myron Scholes, a computer nerd, completed his PhD at the University of Chicago and became assistant professor of finance at MIT. He met Fischer and talked about their respective researches and projects. They both had the same objective in developing applications of the new financial theory. Moreover, these two men were intellectually complementary. On the one hand, Fischer, a theory guy, questioning and reserved. On the other hand, Myron, a data guy, brash and outgoing.

In 1969, Fischer started his own consulting practice, the Associates in Finance, with Myron Scholes as first associate. Their big client was Wells Fargo Bank. Despite strong competition, they were the best consultants ever hired by the bank. It was the occasion to implement their vision of CAPM.

Fischer loved to work for Wells Fargo Bank because it was the perfect combination of detachment and engagement. Few years later, he did the same for Goldman Sachs.

Pg 93-98

Fischer tries to explain the world through the CAPM. Timid people may use the CAPM to limit their risk while aggressive people would use the CAPM to find more risk. CAPM could be used not only to assess stock risk, but also riskless borrowing and lending. The bank could use CAPM to determine how much money to lend to high-tolerance people based on deposits from low-tolerance people. CAPM would be used to balance the money supply between stocks and banks, and between lenders and borrowers. No need for government policy.

Fischer’s CAPM could be applied to business cycles and life events, as well. More risky endeavors may return higher average yields, but would fluctuate more than a less risky option. Instead of the government intervening when, say, a certain crop doesn’t return an expected yield, people should understand the risk they took on and alter their plans accordingly.

Even though the world is not perfectly efficient and logical, Fischer, intently fascinated, believed the CAPM can explain many concepts in a field known today as macroeconomics.

Pages 91-93

During his college years in Harvard, Fischer never needed to follow Lintner’s instructions in order to comprehend the CAPM.

Thanks to what he learned on CAPM from Treynor, Fischer considered the economy as a whole. The problem faced by the individual investors and the individual firms came from, according to Fischer, the idea of equilibrium. On the contrary, the other economists thought that equilibrium was the solution of these problems.

Few years later, in 1969, Fischer published his first economic paper on monetary theory, the Financial Note No. 7. Meanwhile the summer of 1969, when the Woodstock music festival and the peak of the Vietnam War occurred, Fischer, far away from the protests, “was busy spinning a countercultural vision of his own”. He was focused on Treynor and the idea of equilibrium.

Pages 89-91

The new approach to the problem of price variation according Mandelbort, also called the problem of “fat tails”, influenced the work of Eugene Fama. The Mandelbort generalization of the familiar Gaussian random walk earned him bad reviews from Paul Cootner, a professor at MIT. He said that this theory imply that all the previous work in economy are futile.

In 1964, Fama enrolled in the business school faculty at Chicago. His package of efficient markets and fat tails became the major characteristic of the Chicago finance program. Moreover, his course on the very first efficient markets was included in the standard Chicago textbook, The Theory of Finance. The characterization of three level of efficiency by Fama, weak, semi strong and strong became a classic professional reference. But it was still not much a theory.

Pages 87-89

Benjamin King was working on the idea on how new information would cause the stock prices to change. In his research he found that about half of the change in the stock price was affected by the market factor and only about 10% of the change dealt with industry specific factors. This is interesting in that it shows that the market has more of an influence on stock price then what might be happening in the industry.
Lawrence Fisher took Operational Charge of the Center for Research in Security Prices at the Univeristy of Chicago. The center developed a database of historical asset prices from 1926 to 1960 along with constructing a daily record of stock prices. Through this research Fisher and Lorie were able to calculate the average return over the entire period showing that the average yield of 9% was much higher than other investments.

Pages 85-87

Sharpe’s wrote his thesis on CAPM showing how to go from both individual’s stock and market risks to the portfolio weights which optimize the risk/return trade-off.

Basically, when the market has reached equilibrium and only one factor market is driving returns, the set of efficient portfolios is the set of diversified portfolios. If a stock offers a lower expected return than required by its market sensitivity, its price would fall down and its expected return would rise. In the opposite case, the price would rise and the expected return would go down.

Relying on the single factor intuition, Lintner’s version may appear more general than Sharpe’s but on the other hand, Sharpe's work justified the empirical market model suggested by Benjamin King.

King’s idea was that stock prices change because of new information: some affecting the entire market, some affects only certain industries, the last ones specific to an individual firm. He found a common factor called the market factor which is responsible for at least half of stock price fluctuation.

75-79 Better Late Than Never!

Lintner, through a serious of interesting events both in his own life and the world around him, eventually built a bridge between the economics and business departments of Harvard, which had until that point been fairly separate and autonomous entities.

During his time there, Lintner worked on quantifying the decision-making process of internal firm investment. Typical thinking dictated that a firm should continue to invest as long as the marginal return on that investment was greater than the cost of capital.

However, Lintner found that there was not adequate thought given to the riskiness and the potential rewards for a riskier investment. The question of risk again becomes extremely important.

Pg 82-84

Lintner presented his CAPM model before Raiffa and Schlaifer. These two did not see how his model refuted Modigliani-Miller, but did use Lintner’s math to explain some of their arguments in a textbook they were beginning on Statistical Decision Theory. In fact, Raiffa and Schlaifer only saw Lintner’s model as further explanation of covariance of one stock within a portfolio.

Still determined, Lintner knew variance also had something to do with his pricing model, not just covariance. Sharpe published his own CAPM theory in 1965. Lintner was sure Sharpe’s model was wrong and successfully convinced him so. Still not knowing exactly how, Lintner continues to search for a more accurate pricing model that would include an asset’s variance.

Pages 73-75

Economists were slow to pick up on the CAPM model that Treynor had developed. The first two economists to publish their CAPM ideas were William Sharpe and John Lintner in 1964 and 1965, respectively. All of the CAPM approaches being developed at this time were looking at the problem from different perspectives. During a three year span, Fischer learned economics mainly through relaying messages from Lintner to Treynor about how the economic CAPM model worked.

Pages 79-82

Lintner started his analysis with the M&M paper (written by F. Modigliani and M. Miller), even though he knew that at an extent, the theory defended in this paper- independence between a firm value and its financial policy- was inaccurate. Indeed, due to the importance of uncertainty in the real world, he was convinced that financial policy would affect the firms by affecting the riskiness of its future profits.

As a result, he developed his theory of the “valuation of risky assets” -which led him to theCAPM- and he modified the well-known formula of future earnings by introducing certainty equivalents for troublesome expected values.

Lintner’s model of asset pricing was focused on the independent risk unique to a given firm taking into account only the effect of the covariance. His main conclusion for the CAPM, was that the solution was to hold a widely diversified portfolio (both high and low variances stock) to reduce the risk of an investment.

Pages 69-72

The Institute of Chartered Financial Analysts was formed in 1959. It was the first professional organization of financial analysts. Thus, few years later, financial analysts had to retool in order to meet the increasing demand of investors. Treynor, as new editor of the Financial Analysis Federation after the death of Nicholas Molodovsky, highlighted the fact that science would be the future of the profession instead of craft. This shift was possible thanks to computers, who inaugurated new investment analysis methods. He also emphasized the need for financial analysts to focus on institutional investors (mutual funds or pension funds).

Treynor worked with Fischer in order to rally to his cause the support of old guard to something new in financial analysis. Their relationship led to a lifelong partnership. Indeed, Treynor employed his experience into “ideas in the rough” and Fischer processed them. But, if Treynor and Fischer were apparently both supporting a particular model and analytical approach, they were defending the worldview that model had crystallized for them many years before.

Pages 65-69

The management of colleges and universities funds is not really good in the US and the new president of the Ford Foundation, Mc George Bundy, wanted to improve it with the learning of how to make more money with their endowments. The research was led by the CRSP (Center of Research in Security Prices) at the University of Chicago. James Lorie, director of the CRSP, convinced Fischer to work on this project, which had two main objectives: to collect information on investment practice from university treasurers around the country and to develop appropriate methods of portfolio performance evaluation.

Two theories were opposed, one shared by the academics whose belief was that markets were efficient but the security analysis futile; the other coming from the practitioners who thought the markets as inefficient in opposition to the crucial necessity of the security analysis to improve any portfolio performance. As a result, Fischer, in collaboration with Treynor, proposed a new financial way to allocate funds between two portfolios with a passive one reflecting the academicians’ theory and an active one, reflecting the ambition of practitioners.

This research highlighted the way Fischer liked to work, by buckling down to the same problem from two points of view simultaneously.

Pages 59-64

Mutual fund popularity was growing so fast in the 1960s that the government stepped in with the Investment Company Amendments Act of 1967. The concern around mutual funds was that there was no proof showing that they were actually performing well enough to justify the fees they charge. The mutual fund industry hired ADL to back them up. Fischer Black arranged a meeting with two other leading researchers on CAPM and efficient markets, each with a unique outlook on the problem. Their findings were basically that, although mutual funds are a better value than brokerage firms, they do not outperform the market. They made a deal in which ADL still argued their case on the basis that they are the best value and are competitive therefore regulated by the market. In return, ADL was allowed to include their findings in the case committee files. Afterward, Fischer got married and began publishing his own financial papers.

55-57

After getting his MBA from Harvard, Jack Treynor began working at ADL in 1956. However, a problem remained from time he spent working with a Harvard professor: He didn't understand how to accurately choose a discount rate when determining present values.

On a "vacation" to Colorado, Treynor spent three weeks producing 44 pages of mathematical notes regarding the formulas behind choosing an appropriate discount rate. ADL gave Treynor permission to spend time at MIT, working under the direct supervision of Franco Modigliani where he laid the framework for what would be known as the capital asset pricing model, stating that an asset's price depends on its level of systematic risk.

Pages 57-59

While working for ADL Treynor worked on valuing a risky stream of future earnings. He wanted to first calculate the market-clearing risk premium on each economic variable in a moment in time and then to trace the evolution of these variables. Treynor used the CAPM model to help explain some of these questions but was unsuccessful in answering all of them. His research led him to find a benchmark on which financial managers could be measured.
The ADL report was produced to develop ways for evaluating performance of Yale's portfolio managers but Treynor was unable to convincing top management the potential of his methods and he had to leave.

A pause for life

While at ADL, Fischer moved through a number of relations, which really had more to do with life than with his ideas of finance. One of these relationships involved Fran Wilkins to whom Fischer was engaged, but never married because of a terminal illness she was diagnoses with shortly before their wedding. This relationship seemed mainly motivated by Black’s desire to emulate his great uncle Floyd-Black, in marrying a beautiful intellectual.

A few years after Fran’s death from Lou Gehrig’s disease Fischer found love again with Miriam Allen. Fischer was so taken with Ms. Allen; he ignored both his parent’s vehement disapproval, and his friend’s gentler suggestions that there were better matches he could find. Part of Fischer’s stubbornness came from his desire to have a normal life including a family with children.

49-51

Black began working at Arthur D Little, a management consulting firm, in the 60's, taking his first commercial consulting gig with MetLife. Black and his associate Alan Loss, helped MetLife cut costs by optimizing their computer usage.

Also, Black had a girlfriend that helped him learn how to rationalize dishonesty.

Pg 46-47

Fischer’s childhood ambitions consisted of the desire to be extremely creative and to think ideas that have never been thought before. However, this extreme creativity also harvested craziness that society looked down upon. To balance logic and creativity Fischer turned to the metaphor of man-computer symbiosis. The “man” allowed Fischer to be as crazy and creative as he wanted, while the “computer” checked the logic of his creative ideas.

Towards his last year at Harvard Fischer struggled finding work that he enjoyed, he bought a new apartment, and became involved in the Civil Rights Movement. Fischer’s father wanted him to pursue a career in business, but Fischer wanted to find a career in writing. In the end he took a consulting job at Arthur D. Little, a local consulting firm. He looked forward to his new job, helping businesses make better use of their computers.

Pg 43-46

Fischer did a PhD in applied mathematics. His dissertation was about a logical system to answer questions. Fischer was noted for being very logical but also very crazy. He was always coming up with ideas. He stored his ideas in manila file folders in order to refer to them later. He claimed that would keep his mind free and able to do other things. His logic kept him on track doing routine things. His creativity allowed him to venture out and be as crazy as he wanted.

How Fischer turned a bad event into a great learning and improving experience opportunity (Pages 39- 43)

Soon after his dismissal from Harvard, Fischer found a job at the consulting firmBolt Beranek and Newman (BNN). His main project, was on a computer-based information retrieval systems for a study directed by J.C.R Licklider (vice president of BBN) and inspired by Licklider's article on"Man-computer Symbiosis".

Yet in September 1962, Fischer started working on a computer program able to deduce answer to simple questions. Unfortunately, this system, highlighted by Licklider as "a signal advance in automated question answering", was still limited by the computer memory and calculation speed of that time.

In spring 1963, to be more efficient on this project, he took the grammar of English and in semantics class at MIT, where he was first introduced to the "Fairly easy" English method as recommended by Rudolf Flesch. That consists in the origin of Fischer's distinctive mature writing style. Fischer once said: "Make your style simple, not complicated", what he did by expressing himself in English rather than in mathematical language.

Pages 37-39

Black's last full year in college was in 1961. Many of the political upheavals seen in the '60s were beginning. Not only war, but experiments with hallucinogenic drugs on students (and most likely some unofficial experiments by students) were beginning. Many riots and protests were starting, and Black found the challenge to authority that they represented tempting. Black was arrested for, apparently, loitering in Harvard Square. When a dean was sent to get him out of jail, he almost didn't take the chance, being "surly”, and "insolent." Black's rebelliousness was miss focused though (seems to be a theme with him), because he the authority that he really disliked was his adviser, Anthony Oettinger. Black refused to see Oettinger's efforts as aid, and made no real progress on his thesis, and as a result was kicked out of Harvard in the spring of 1962. This actually brought some relief to Black partly because of the increased independence, and also, in his own words "for the first time in 19 years I am out of School for more than a summer." I don't blame him.

Pages 35-37

Once in graduate school Fischer became very interested in computers and was determined to create a computer that could think like a human being. He began taking psychology classes to help him with both developing a computer as well as raising a child. However, Fischer's dedication to his quest for artificial-intelligence quickly got in the way of his marriage. Within a year of his son, Fischer Sheffey Black III being born Fischer and Tinna were divorced. Tinna married someone else, relocated, and even changed the child's name since Fischer gave up all his parental rights. Meanwhile at Harvard, faculty forced him to focus his brilliance and produce some results.

Pages 31-35

In college Fischer did not put any restraints on who could be his roommates just as long as they were different from him. During his college experience he acted rebellious to some of the assignments or discussions in the classroom. He would write his papers on what interested him and not on the assigned topic or he would argue about minor details.
Throughout college he would take notes on himself. These notes would not mean anything to anyone and he was most likely looking for patterns in himself. He knew that he was different from other people so the things that he did find out about himself were not significant.
Fischer spent most of his time as a sophomore with the graduate students and even taking advanced classes in Social Relations that graduate students would take. One of his closest connections was his sophomore tutor Karl Reisman, a graduate student. Fischer would try to talk the graduate students into trying hallucinogenic drugs as an experiment. When taking these drugs himself he would take notes often to record what he was feeling. He also tried to change his sleep patterns to see what effect this had on his mental state.
By the end of his sophomore year he lost interest in Social Relations and his interests turned to other subjects. In May 1958 Fischer changed his major to physics and on July 12, 1958 he married Tinna.
In October Fischer applied to graduate school at Harvard, his only choice in schools. Scoring a 870 out of 900 on the Graduate Record Exam in Physics Fischer was accepted into Harvard.

Pages 28-31

Fischer Black was born January 11^th, 1938 in Georgetown. Shortly after being born his parent’s moved the family to Falls Church, a rural area outside of the city. Fischer’s youth consisted of a comfortable, accepting, country life. He spent most of his time as a young child catching crawfish in the stream behind their house, fishing, and tending the garden with his father. However, Fischer’s father taught him to read at the age of four and his brilliance was recognized very early on as his Kindergarten teacher called him the smartest student she ever had.

At the age of 10, Fischer’s family relocated to Bronxville where he would enter the sixth grade at 10 years old, a result of skipping a grade. This is about the time that Fischer’s true nature was confirmed. He was attending one of the top public schools in the country and often turned down offers from classmates to come out and play, choosing instead to stay inside with his family and his books. As Fischer progressed in his education and exposure to new ideas, he quickly developed a tendency for questioning conventional wisdom. Often, he would test his ideas and questions out on his family and as he grew more comfortable, he would test them on his professors. Fischer’s habits for questioning authority began at a very young age, but the effect it had on those being questioned was lost on him for he was never interested in fitting in.

As he grew older, Fischer made his first true emotional connection with his first girlfriend, Cynthia “Tinna” Carpenter. They met one summer between high school and college on a school trip to France and Switzerland and quickly fell for one another. Once they returned home the first couple years of their relationship were long-distance, writing each other every day and visiting whenever possible. However, Tinna’s family was well above the Black’s in social status and her parent’s did not approve of Fischer and his unconventional, questioning ways. Tinna did not care and she found Fischer’s willing to question convention quite attractive. In Fischer’s third year of college the two were married and had their first child shortly after that. Things did not work out and the marriage eventually ended but Fischer still found comfort in the idea of marriage, children, and having a family.