How Genius Works

On Monday, October 7, 2002, the Department of Economics' Distinguished Lecturer Series, with the support of the Allen Starling Johnson, Jr., Fund, presented a lecture by Perry Mehrling, Professor of Economics, Barnard College and Columbia University entitled "How Genius Works - Inside the Mind of Fischer Black."

Understanding Fischer Black

Fischer Black as Macroeconomist

Fischer Black and the Revolutionary Idea of Finance

Fischer Black was one of a kind. Those of us in his academic years saw a brilliant scholar who was strikingly origional in his approach to problems, and a fount of ideas, many of which were viewed, at the time, as "off the wall." This book not only covers his professional contributions, but also presents enough of his personal life to help somone like me, who knew him but not all that well, to appreciate where his thought came from. Another good thing about this book is the recognition the author gives to Jack Treynor, a man who did not get the recognition he deserved as the developer of some of the seminal ideas of finance. Fischer's research, and teaching style, was unlike that of anyone else in our profession, and now I have better understanding of why.

The original rocket scientist on Wall Street.

This is an outstanding book about a finance revolutionary. This biography is as interesting as Sylvia Nazar "A Beautiful Mind" about John Nash, the pioneer of Game Theory.

Fischer Black, the human being was as interesting as Nash. As a young man, he was quite the adventurer and engaged in casual sex and taking LSD. But, after suffering a failed marriage and the death of a close friend he recognized the risk of those activities. Thus, he started to live by the CAPM motto to manage the risk in his own life. He drove safe cars, wearing seatbelts before it was mandatory and adhering to a strict diet (fish and vegetables). He married another two times to finally get it right. During his second marriage, when it was not working out, he would seek female companions by posting personal ads in the local paper. And, he would encourage his wife to do the same! Later, he met his third wife through a dating service.

Fischer Black became famous for what he cared less about: the Black Scholes option model. Options were just a passing interest. He cared more about CAPM developed by Jack Traynor. His lifelong ambition was to apply CAPM to economics.

He failed to leave a legacy in economics. Perry Mehrling explains why. Fischer Black had degrees in physics and mathematics but no formal training in economics. His General Equilibrium theory clashed with both Keynesians and monetarists. While at Chicago, his General Equilibrium theory got no respect from Milton Friedman, the leading monetarist. Later, Paul Samuelson, the leading Keynesian at MIT, treated him just as badly. He could not get his economics papers published. In academia he became recognized as cutting edge in finance, but out of his depth in economics.

Fischer was very much egoless. He took all the rebuttals from economics luminaries in stride. They never discouraged him to pursue his economics research. Also, he quickly adopted the binomial tree option model developed in 1976 by Cox-Ross-Rubinstein. He viewed it as faster and more flexible than his own Black Scholes model. Other common mortals would have hung on proudly to their own model. Not Fischer Black!

Before Fischer Black finance was a minor discipline to economics. After Fischer Black, the reverse is truer. Even though he was the original quant on Wall Street, he really did not think like one.

Fischer Black thought like no one else. While his MIT colleagues would attack problems head on with formulas and models, Fischer Black would not. He would explore a problem from as many different angles as he could think. Once he had essentially solved the problem conceptually in his head he would finally generate the formula. The formula was just the concrete representation of his solution. If you developed a formula first and a solution second, as his MIT colleagues did, you would get stuck in a thinking rut dictated by your formula.

His teaching methods were bizarre. He got bored teaching already acquired knowledge. Thus, he felt regular lectures were a waste of time. It would be better for students to spend the time studying the textbook directly. However, he developed a teaching style he and his students found engaging. He came up with a list of 50 questions explorative in nature. This helped him pick ideas from brilliant young minds. His students loved it, because it turned the class into a vibrant seminar.

Fischer Black pioneered many concepts that resulted in new financial markets. In 1969, as a consultant for Wells Fargo with Myron Scholes, they propose three passive investment strategies never thought of before. One was the equivalent of an index fund and another a hedge fund. As a result of this work, Wells Fargo introduced the first S&P 500 index fund to institutional investors in 1973. And, John Boggle of Vanguard did the same for retail investors in 1976. His work on options in the late 60s lead to the opening of the Chicago Board Options Exchange in 1973. His work on valuing futures in 1976, lead to the Merc introducing such contracts on the S&P 500 in 1983. Later, when working for Goldman Fischer developed the first computer trading system. There, he also co-developed the Black-Derman-Toy model to value any fixed income derivative product(e.g. interest rate futures). Thereafter, the entire derivative market really took off.

If you like this book, you will like Roger Lowenstein "When Genius Failed. The Rise and Fall of Long Term Capital Management." It describes the fascinating tragedy of how Fischer Black colleagues Myron Scholes and Robert Merton tarnished their reputation by co-founding a hedge fund that needed to be bailed out. Fischer Black was prescient in figuring out they were loading on risk (time dimension) and turned down the offer to join LTCM. Thus, Fischer Black legend goes on.

A Careful and Thorough Biography of a preeminent financial economist by a preeminent economic historian

Perry Mehrling has done a superb job of illuminating the life of Fischer Black, one of the most original and creative financial economists ever. To me the most fascinating aspect of this work is the revelation about the interplay of ideas between Fischer Black and Jack Treynor. The book's subtitle, "the Revolutionary Idea of Finance", refers to the Capital Asset Pricing Model (CAPM), for which another great economist, William Sharpe, won the Bank of Sweden prize in economics. Whereas Sharpe's original CAPM was a partial equilibrium model, Fischer Black was the protege of Jack Treynor, who had developed the general equilibrium CAPM independently of Sharpe several years earlier. Black learned full-equilibrium CAPM from Treynor and used it to derive the famous Black-Scholes options pricing formula, for which his co-developers, Myron Scholes and Robert Merton, later won the Bank of Sweden Prize. Mehrling shares with us fascinating evidence of how Black actually led his personal life by the tenets of CAPM and economic equilibrium. I am currently teaching a course in financial engineering at Columbia University, and the single most important supplemental reading I assigned was Mehrling's "Fischer Black and the Revolutionary Idea of Finance". Anyone interested in financial economics, macroeconomics, or creative thinking should own a copy of Mehrling's wonderful treatise. [http://economists.idoneos.com/]