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.
A for John Doe.
ReplyDeleteInteresting: an arbitrage opportunity created by too many people not knowing the math of arithmetic and geometric averages well enough. And you thought business classes would have no math ...