The Nobel Prize

Myron S. Scholes (b. 1941)

Myron Scholes was born in Timmins, Ontario, Canada in 1941. His father was a dentist and his mother worked for a time in a family business. While in his teens Scholes suffered heavy losses: the death of his mother and problems with his vision that made reading difficult. His poor eyesight forced Scholes to adjust the way he learned: he had to ‘think abstractly and to conceptualise the solution to problems’ (Nobel Foundation, 2004). Surgery improved matters but not until ten years later. Scholes developed an interest in economics and finance because of a strong streak of entrepreneurship running through his family. Like fellow Laureate, Robert Merton, with parental encouragement he played the stock market while still at school.

Scholes majored in economics at McMaster University in Ontario, and graduated in 1961 with a BA. He had plans to join his family in business but first entered graduate school at the University of Chicago. As an undergraduate, Scholes had been particularly impressed by the writings of future Chicago Nobel Prize winners George Stigler and Milton Friedman (see entries in this volume). Scholes recalls that his time at Chicago ‘changed the direction of my life forever’; there would be no career in the family business (Nobel Foundation, 2004). The turning point was a summer job as a computer programmer at the university. This exposed Scholes to the research work of a series of economists (including the 1990 Laureate Merton Miller); it is not difficult to understand that he found the experience ‘empowering’. He became a skilled programmer – ‘I must have been one of the first computer nerds’ – to the extent that he was even able to offer suggestions about research design to those he was assisting (Nobel Foundation, 2004). At Miller’s suggestion, Scholes began work on a PhD. Chicago awarded him an MBA in 1964 and a PhD in 1969.

Scholes’s first academic appointment was as Assistant Professor of Finance at the A.P. Sloan School of Management at the Massachusetts Institute of Technology (MIT) in 1969, where he was subsequently promoted to associate professor. At MIT he began to work with Fischer Black, who was then a private consultant, and his new colleague Robert Merton. Scholes returned to the University of Chicago in 1973, first as visiting associate professor and then as professor. Black had become a professor at Chicago in 1972 and Scholes wanted to continue to work with him, Merton Miller, and another economist he knew from his days as a graduate student: Gene Fama (Nobel Foundation, 2004). After a visiting appointment at Stanford University in 1981, Scholes moved there permanently in 1983. Since 1996 he has been Frank. E. Buck Professor of Finance, Emeritus at Stanford.

Scholes’s offices and honours include honorary doctorates awarded by three universities: McMaster, Paris-Dauphine and Katholieke Universiteit Leuven in Belgium. Scholes’s professional appointments include several directorships; with Robert Merton and others, he was also a co-founder of Long-Term Capital Management, the hedge fund subject to an infamous rescue organised by the Federal Reserve in 1998 (see Edwards, 1999). He is a research associate of the National Bureau of Economic Research. In 1997 Scholes was awarded the Nobel Memorial Prize in Economics jointly with Robert Merton ‘for a new method to determine the value of derivatives’ (Nobel Foundation, 2004).

In the preceding entry in this volume – for Robert Merton – we review the nature and significance of the option-pricing formula for which Merton and Scholes have been honoured by the Royal Swedish Academy. Rather than covering the same ground in the present entry, we shall instead highlight some of the notable experiences of Scholes and his late colleague Fischer Black during the course of their Prize-winning work; we conclude with some brief references to Scholes’s later work.

The history of the paper containing the original Black–Scholes formula for the pricing of an option contract (Black and Scholes, 1973) is both interesting and illuminating (see Black, 1989 for the most commonly cited version). As is well known, Black and Scholes had serious difficulty getting the paper published. An initial submission to the Journal of Political Economy in late 1970 was rejected without review, and the editors of the Review of Economics and the Journal of Finance also agreed that the paper was unsuitable for their readerships (Schaefer, 1998; Scholes, 1998). On the intercession of Merton Miller and Eugene Fama, with whom Scholes has worked at the University of Chicago, the Journal of Political Economy accepted the paper after it had been revised and broadened to consider the implications of option contract theory for the analysis of corporate liabilities (see Duffie, 1998; Jarrow, 1999; Schaefer, 1998). Black and Scholes had intended to hold this extension over for inclusion in a later article (Scholes, 1998). This is yet another reminder that even economists capable of Nobel Prize-winning work sometimes suffer in the capricious process that is decision making by journal editors. In a further irony, a paper testing the optionpricing formula (Black and Scholes, 1972) was actually published before its theoretical exposition. Our entry on Robert Merton attests to the widespread application and impact of the option-pricing formula following the work of Black, Scholes and Merton. Scholes offers an additional and, in retrospect, amusing anecdote (he must have been at least a little annoyed at the time). In 1974, Texas Instruments produced a calculator that directly used the Black–Scholes model. Scholes asked for royalties but the company claimed the work was in the public domain. When he asked for a calculator they advised him to buy one. He didn’t! (See Scholes, 1998.)

In addition to his work on option pricing, Scholes has, with Black and Miller, published notable papers on the impact of dividends on stock valuation (Black and Scholes, 1974; Miller and Scholes, 1978; 1982; see Nobel Foundation, 2004). With Joseph Williams he has done work on the estimation of risk using nonsynchronous data (Scholes and Williams, 1977) and with Mark Wolfson he has written a book bringing together a number of papers on corporate taxation (Scholes and Wolfson, 1992).

Main Published Works
(1972), ‘The Valuation of Option Contracts and a Test of Market Efficiency’ (with F. Black), Journal of Finance, 27, May, pp. 399–417.
(1973), ‘The Pricing of Options and Corporate Liabilities’ (with F. Black), Journal of Political Economy, 81, May–June, pp. 637–54.
(1974), ‘The Effects of Dividend Yield and Dividend Policy on Common Stock Prices and Returns’ (with F. Black), Journal of Financial Economics, 1, May, pp. 1–22.
(1977), ‘Estimating Betas from Nonsynchronous Data’ (with J. Williams), Journal of Financial Economics, 5, December, pp. 309–27.
(1978), ‘Dividends and Taxes’ (with M.H. Miller), Journal of Financial Economics, 6, December, pp. 333–64.
(1982), ‘Dividends and Taxes: Some Empirical Results’ (with M.H. Miller), Journal of Political Economy, 90, December, pp. 1118–41.
(1992), Taxes and Business Strategy: A Planning Approach (with M.A. Wolfson), Englewood Cliffs, NJ: Prentice-Hall.
(1998), ‘Derivatives in a Dynamic Environment’, American Economic Review, 88, June, pp. 350– 70.

 Secondary Literature
 Black, F. (1989), ‘How We Came Up With the Option Formula’, Journal of Portfolio Management, 15, Winter, pp. 4–8.
Duffie, D. (1998), ‘Black, Merton and Scholes – Their Central Contributions to Economics’, Scandinavian Journal of Economics, 100 (2), pp. 411–24.
Edwards, F.R. (1999), ‘Hedge Funds and the Collapse of Long-Term Capital Management’, Journal of Economic Perspectives, 13, Spring, pp. 189–210.
Jarrow, R.A. (1999), ‘In Honor of the Nobel Laureates Robert C. Merton and Myron S. Scholes: A Partial Differential Equation That Changed the World’, Journal of Economic Perspectives, 13, Fall, pp. 229–48.
Schaefer, S.M. (1998), ‘Robert Merton, Myron Scholes and the Development of Derivative Pricing’, Scandinavian Journal of Economics, 100 (2), pp. 425–45.

No comments: