November 15, 2008
niall ferguson and the death of planet finance
This year we have lived through something more than a financial crisis. We have witnessed the death of a planet. Call it Planet Finance. Two years ago, in 2006, the measured economic output of the entire world was worth around $48.6 trillion. The total market capitalization of the world’s stock markets was $50.6 trillion, 4 percent larger. The total value of domestic and international bonds was $67.9 trillion, 40 percent larger. Planet Finance was beginning to dwarf Planet Earth.Planet Finance seemed to spin faster, too. Every day $3.1 trillion changed hands on foreign-exchange markets. Every month $5.8 trillion changed hands on global stock markets. And all the time new financial life-forms were evolving. The total annual issuance of mortgage-backed securities, including fancy new “collateralized debt obligations” (C.D.O.’s), rose to more than $1 trillion. The volume of “derivatives”—contracts such as options and swaps—grew even faster, so that by the end of 2006 their notional value was just over $400 trillion. Before the 1980s, such things were virtually unknown. In the space of a few years their populations exploded. On Planet Finance, the securities outnumbered the people; the transactions outnumbered the relationships.
more from Vanity Fair here.
Posted by Morgan Meis at 01:50 PM | Permalink
Comments
Thanks very much for the article. Amazing. Maybe Scholes and Merton should have been awarded an Ig Nobel.
From the VF article: Working closely with Fischer Black, of the consulting firm Arthur D. Little, M.I.T.’s Myron Scholes invented a groundbreaking new theory of pricing options, to which his colleague Robert Merton also contributed. (Scholes and Merton would share the 1997 Nobel Prize in economics.) They reasoned that a call option’s value depended on six variables: the current market price of the stock (S), the agreed future price at which the stock could be bought (L), the time until the expiration date of the option (t), the risk-free rate of return in the economy as a whole (r), the probability that the option will be exercised (N), and—the crucial variable—the expected volatility of the stock, i.e., the likely fluctuations of its price between the time of purchase and the expiration date (s). With wonderful mathematical wizardry, the quants reduced the price of a call option to this formula (the Black-Scholes formula):
[magic formula here]
in which:
[magic formula here]
Feeling a bit baffled? Can’t follow the algebra? That was just fine by the quants. To make money from this magic formula, they needed markets to be full of people who didn’t have a clue about how to price options but relied instead on their (seldom accurate) gut instincts. They also needed a great deal of computing power, a force which had been transforming the financial markets since the early 1980s. Their final requirement was a partner with some market savvy in order to make the leap from the faculty club to the trading floor. Black, who would soon be struck down by cancer, could not be that partner. But John Meriwether could. The former head of the bond-arbitrage group at Salomon Brothers, Meriwether had made his first fortune in the wake of the S&L meltdown of the late 1980s. The hedge fund he created with Scholes and Merton in 1994 was called Long-Term Capital Management.
opinionjournal
nobelprize
Posted by: CriticalMassI | Nov 15, 2008 3:36:55 PM
i read ferguson's war of the world--massive tome. does anyone know if sasha baron-cohen (borat) really studied under ferguson at cambridge?
Posted by: spencer | Nov 16, 2008 2:51:15 AM
Comparing dollars to dollars/year is meaningless.
Strange that such flagrant ignorance of dimensional analysis is being flaunted here of all places.
Posted by: Roi | Nov 16, 2008 2:15:50 PM
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