Mathematician and financial economist Szpiro (Numbers Rule: The Vexing Mathematics of Democracy, From Plato to the Present, 2010, etc.) chronicles the co-evolution of modern finance, physics and statistics.
In 1997, the Nobel Prize was awarded to economists Myron Scholes and Robert Merton for determining “the true value of an option,” just one year before the billion-dollar hedge fund they founded nearly collapsed global financial markets. The prize was based upon their discovery—along with their deceased collaborator Fischer Black—of a formula that laid the basis for computerized derivatives trading. In the author's opinion, despite the spectacular real-world failures of their model, which also contributed to the 2007 economic crisis, on a scientific level, their achievement “is a landmark achievement of the twentieth century.” While this may strike readers as unwarranted hyperbole, Szpiro unravels the complexity of the Black-Scholes equation and its fascinating relationship to Einstein's application of statistics in explaining the random motion of molecules and to Norbert Wiener's discovery of Cybernetics (based on his World War II work on target acquisition). In the case of options, it is option prices rather than molecules that jiggle. The author devotes most of the text to tracing “the historical and intellectual developments that led to the options pricing formula,” beginning more than 300 years ago with the tulip bubble, when frenzied speculators drove the price higher and higher until the bubble burst and buyers defaulted on future contracts.
An interesting history of mathematics and its application to economics and the world of high finance.