Risk and Time

Beginning with a solid background in CAPM, Black was ready to consider risk as it really was. One of the first things he noticed was the incredible amount of risk that time imposes on people and investments. This risk stems from the ever changing nature of the world in which we live. With our understanding and visions as limited as they are, we need another way to consider the risk that time forces onto us.

One area in which Black noticed great opportunity for improvement was future wages. Black noted that wages are one the primary method people accrue wealth. Jobs with the highest wages require high levels of specialization. The high levels of specialization expose people to risk. One possible counter to this risk, is to diversify the skill they posses. Black followed this council as he successfully worked in both academia and business.

Another way people can safeguard their future wages is to form long term contracts. These contracts give people the stability and commitment that are necessary to endure the shifts that so frequently sweep the business world. This is similar to a reinvestment risk that investors should consider when searching for proper investments.

The final way that risk over time can be countered is through the use of simple models. Black noticed that simple models have a tendency to survive much better than complicated ones. Similarly, people who have simple marketable skills tend to fare better than people with highly technical and therefore transient skills. Nothing showed these beliefs more than Black’s adherence to the CAPM model, or his later options pricing model.

Pages 10-12

After establishing himself at Goldman Sachs, Fischer Black published his second book Exploring General Equalibrium. The book had been a long time coming, with 30 years of hard thought put into the book. The book looked at large and complicated economic problems from Black's brilliant finance point of view. Being Ignorant and close-minded most economists set aside the ideas in the book, holding fast to their narrow ways of thinking.

Black was born in 1938, into a generation that took foolish risk on as second nature. In his younger years Black took dangerous risks that only had life threatening rewards. He took on a lifestyle of sex and drugs. Black's first marriage ended in a bitter divorce, only to move on to watch his second fiancee die a slow death. Black hit rock-bottom, and found comfort in the Capital Asset Pricing Model (CAPM) of all things.

The CAPM gave Black a scientific basis to measure risk and reward. He no longer took risks that didn't potentially have a great reward. He viewed the principles of the CAPM far beyond stocks and markets, it was now a scientific way to make conscious decisions. Black's lifestyle flipped a 180: he substiuted alchohol for water, his drugs were now vegetables and whole foods, he became a safe driver and wore his seat belt, and took all precautions too prevent cancer.

Pages 7-10

Fischer Black was not one for conventional wisdom. He enjoyed finding a better solution to a problem that had already been solved to the satisfaction of most. If there was a problem whose solution wasn't perfect, he would toss aside that solution and find one that was.

Unfortunately this didn't quite endear himself to all his colleagues. Many of his theories were rejected at the time of their introduction, only to find acceptance later, and some are still under debate.

His greatest success, the Black-Scholes model, traveled almost instantaneously from the domain of academia to the desks of the professional world. This model, along with others he developed throughout his career, have established his prominence in the financial world as an expert across several disciplines.

Black looked at financial problems the same way he looked at video games, finding new and better ways to solve old problems. For him, merely reaching the goal wasn't enough, he wanted to find the best solution.

Perhaps the greatest lesson to be learned from Fischer Black is that what is accepted is not always true. To the chagrin of many of his colleagues, he always questioned the way things were done.

One of capitalism's most enduring traits is the importance of innovation. New and better ideas are accepted by the marketplace, sustaining further economic growth. In this regard, Black's manner of questioning everything should be not only adopted, but encouraged.

Though the American academic system rarely - if ever - encourages or rewards challenging the status quo, the innovative spirit should always be kindled if any economy hopes to thrive.

Fischer - World Without Money Pg 4-7

Fischer presents an interesting thought experiment in this section of the book, specifically, a world without money. This needs a little definition. There would still be capital, and credit that could be spent with checks or credit cards, but there would be no "quantity of money" as Fischer says. A person would have no currency, but a single bank account that is either positive or negative.

Banks would administer these accounts, and make money off of interest charged on transactions and loans, which are negative accounts. There would be nothing to stop an account from transferring from positive to negative, or negative to positive. What would change would be whether the account is getting charged interest or credited interest. There would be a limit on the amount of loans an account could have. This limit would have reference to what the bank thought that the person or business could pay off. As long as they didn't get near or exceed this limit, the bank has little to worry about, because the average person or business would not spend themselves into bankruptcy.

One effects that this would have is that the majority of business financing would happen through the banks, there would be no debt securities. There would be common stock that could be used to retire loans and loans could be used to retire common stock.

So far nothing has been said of how a worker would convert his labor into deposits in the bank. What type of ratio would there be to labor and deposits? I guess it would come from a business transferring some of its deposits/loans into the worker's account, which seems to address my concern.

Pages 1 to 4

I'll do the first one as an example. It's a bit long. :(

Academics aren't good at recognizing the scholarly work of people who are not academics; there just aren't that many people outside of academics doing academic research

Finance is different: top researchers do get paid a lot outside of academics because their research can help their firms make money.

Jack Treynor was the first to develop a version of the capital asset pricing model (the CAPM), but he doesn't usually get recognized. Treynor was a student at Harvard Business School who showed his work to his professor John Lintner, and also to Franco Modigliani (as in, Modigliani-Miller theorem) at MIT. Then he went into private business ... which got academics to stop paying much attention to him.

Lintner does get recognized for the CAPM, as well as a third guy who independently developed the CAPM: William Sharpe. Sharpe did win a Nobel Prize for this in 1990 (shared with Miller of Modigliani-Miller), while Lintner died before he was given one.

Fischer Black, the subject of the book, is very much like Jack Treynor. He did his most influential academic work outside of academics. Just like Jack Treynor though, Black should have won a Nobel Prize earlier in his life. And ... just like Lintner, he died before one was awarded to a co-author and a competitor.

An Experiment

I'm going to try something new this semester.

A single class is going to read a book together.

The class is FIN 6100. It's titled Advanced Topics In Finance. It's an MBA course in (somewhat) advanced finance - mostly options and derivatives.

The book is Fischer Black and the Revolutionary Idea of Finance by Perry Mehrling. The book is on reserve in our library.

Each chapter of the book is divided up into subsections of several paragraphs. Each student will have to summarize one of these subsections, and build of the earlier summaries. During the semester, each student will have to do a bunch of these. In the end, we'll have a collective book summary.