Back of the Envelope

Observations on the Theory and Empirics of Mathematical Finance

Strands in the History of Mathematical Finance

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If one looks at the historical accounts of the development of modern (mathematical) finance as a discipline (say, for example in Peter Bernstein‘s Capital Ideas) there seem to be three parallel strands:

1. Development of Derivatives Pricing Models: Here I have in mind the discovery of Louis Bachelier‘s thesis by Paul Samuelson (via Leonard Savage) and his and his students’ subsequent work on Warrant Pricing. There was enough empirical evidence accumulated by then, starting from Alfred Cowles (who was also instrumental in setting up of Econometric Society in early 20th century), Holbrook Working and Maurice Kendall.

2. Development of Capital Asset Pricing Model: WilliamsMarkowitz and Tobin paved the way for Treynor-LintnerSharpeMossin asset pricing model. The stage for thinking systematically about risk, however, was set long back by Daniel Bernoulli.

3. Development of Stochastic Calculus and Mathematical Finance: It took a long time for financial economists to learn about Bachelier’s work, but that’s not true of mathematicians. LevyKolmogorov and Doob were all aware of Bachelier, and while filling gaps in his work they laid the groundwork for stochastic calculus developed by Kiyoshi Ito.

While I hope to blog about each strand over the next few months [the key word being ‘hope’ :)], in the next post I start with a short history of developments that eventually led to the Black-Scholes-Merton Option Pricing Model as we know today.

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Written by Vineet

January 15, 2013 at 4:49 pm

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