The Quest to Price Options | The Marginal Revolution Podcast

In the final episode of Season 1, Alex and Tyler explore one of the most consequential quests in the history of economics and finance: the decades-long search for a formula to price options. From Louis Bachelier's groundbreaking work in 1900 to the eventual triumph of Black, Scholes, and Merton in the 1970s, they trace how brilliant minds across mathematics, physics, and economics gradually unlocked the how to properly price financial instruments like calls and puts. Along the way, they examine how this theoretical breakthrough revolutionized modern markets, sparked the creation of the Chicago Board Options Exchange, and transformed our understanding of uncertainty and risk management. The conversation ranges from the hidden histories of early options traders to how options theory now shapes everything from portfolio insurance to oil well investments to mega-sized chip plants. They close by reflecting on how options theory has become fundamental to modern decision-making far beyond trading floors, revolutionizing how we think about and manage uncertainty across the entire economy.

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Chapters -
00:00 - The puzzle of pricing options
03:46 - Louis Bachelier's contribution
09:52 - Enter Paul Samuelson
15:05 - Black, Scholes, and Merton
27:05 - Kassouf, Thorp, and cashing in on options theory
32:28 - Other applications of options pricing theory

Recorded 4/12/2024

[DanHowardMtl]

I love people being excited by these topics. :)

[DF-ssep]

One of my favorite thing about economics is how general it is, things like this fact that options and insurance have a similar structure underneath. Physics has the same thing - for example, a mass and a spring can have the same equation as an electric circuit - but for some reason I never found that as interesting.

[andrewhancock]

I find the stories that they tell to be much more digestible than the math. They said that the math is trending toward incomprehensibility. Outside of the world of finance, I wonder of decision support analysts will be treating these tools like black boxes and and testing them against Monte Carlo models of their own operational problems to see whether they confer an advantage. I mean, I'm sure that these approaches are great for the problems for which they are designed, but the speakers did say that many other problems can be mapped to calls/puts