Источник: Pensions & Investments, 10/27/97, Vol. 25 Issue 22, p3, 2p, 2bw
Burr, Barry B.
NOBEL WINNERS CHANGED HEDGING FOREVER
Myron S. Scholes, co-winner of this year's Nobel prize in economics with Robert C. Merton, calls the award for their work in options pricing "the people's prize."
Those in investment management who use the model say it's as important as the capital asset pricing model.
"It's become the people's prize because the use of the options pricing model became ingrained quickly in the practical world," said Mr. Scholes.
"People have become more facile with options and hedging and risk management techniques."
In the pension fund arena, among other uses, he said, "It produced portfolio hedging and portfolio insurance."
"The important thing to recognize is the specific model, the Black-Scholes model, is still used," said Mr. Metton, whose own work extended its application. The model originally was designed to price a call option.
"It's the standard," Mr. Merton said. Even for pricing exotic options not envisioned when the model was developed, the method of approach is derived from the formula, he noted.
The model also is "often used in contractual agreements," Mr. Merton said. "Rather than quote a price, contracting parties quote a volatility rate." Among those areas is the valuing of corporate executive stock options.
At GTE Investment Management Corp., Stamford, Conn., Michael deMarco, director-risk management, said, "It's become a commonplace tool for us."
He said the staff of GTE Corp.'s billion defined benefit plan use it for monitoring option pricing.
Rex A. Sinquefield, chief investment officer, Dimensional Fund Advisors Inc., Santa Monica, Calif., said the work of Messrs. Scholes and Merton "provided profound insight in how we think about financial assets and liabilities," including equities, bonds, derivatives.
"Fischer Black would have certainly shared in the prize had he lived."
Fischer Black credited too
Indeed, the Nobel citation gives Mr. Black, who died in 1995, prominent credit. Its first sentence reads, "Robert C. Merton and Myron S. Scholes have, in collaboration with the late Fischer Black, developed a pioneering formula for the valuation of stock options." The citation and accompanying materials describing the innovative work refer throughout to "Black, Merton and Scholes."
For Messrs. Scholes and Merton, their academic work in investment theory has a practical side. Both are directly involved in investment management.
They are principals and limited partners in the investment advisory firm, Long-Term Capital Management L.P., Greenwich, Conn. The firm, which they co-founded with several others in 1993, specializes in hedge funds.
Eric Rosenfeld, principal and limited partner, said the firm does "true hedge fund" strategies, "buying cheap assets and hedging risk." It uses the Black-ScholesMerton work.
Mr. Scholes also is a long-time director of three mutual fund companies -- DFA; Benhan Capital Management Group, now part of American Century Investment Management Co., Kansas City, Mo.; and Smith Breeden Group of Investments Co., Chapel Hill, N.C.
Mr. Merton served for eight years -- through 1996 -- as trustee of the College Retirement Equities Fund.
Both have been consultants to Salomon Inc., New York.
Recalling the old days
Before the development of the options-pricing model, Mr. Scholes said, "In the old days there were two ways to reduce risk." One was to diversify among securities in an asset class. The other was to allocate among different asset classes.
But the model made the application of hedging more precise by more accurately pricing options and other instruments.
"What is best for the pension fund depends on transaction costs," Mr. Scholes said.
"It forms the basis for rational quantitative evaluation of risks associated with options," said Seymour N. (Sy) Lotsoff, senior managing director, Lotsoff Capital Management, Chicago.
"It moved it to an objective from an subjective basis. That allowed derivatives and derivative strategies to develop in the last 25 years."
Pension fund and other institutional investors today use the options pricing model or derivations of it for a variety of strategies and risk-management techniques, and to determine the reasonable cost of the strategies.
Among them, Mr. Lotsoff noted:
o Costless" collar hedges, used to protect against a sharp decline in, say, the stock market over the next year. If the Dow Jones industrial average today is around 8000, the pension fund would buy an out-of-the-money equity index put, one with a strike price of, say, the Dow at 7200, paying for the option by selling a call of, say, the Dow at 8800. It would incur an opportunity cost, if the Dow rises above 8800 before the call option expired in one year.
o Options overwriting to gain incremental return, in which a pension executive sells call options on individual stocks in a portfolio to gain the premium from the sale. The fund risks having the stocks called, if they rise in value before the option expires.
o Instruments with embedded options, such as corporate callable bonds.
In the futures market, Mr. Lotsoff said the model doesn't have direct application, because prices of futures contracts are based on the current market price plus carwing costs, based on interest rates. But he said there are peripheral applications through options on futures.
In the swaps market, too, the model's application is indirect, although it would be useful in pricing options on swaps, known as swaptions. In overall risk management, he said pension executives would use the options model to estimate and establish desired maximum risk positions, or limits for a fund's strategies.
As a director at DFA, Mr. Sinquefield said Mr. Scholes encouraged the development of its synthetic enhanced Standard & Poor's 500 Stock Index fund. It combines the use of S&P 500 futures and short-term fixed-income instruments to try to outperform the index.
At the Benham funds, Mr. Scholes encouraged the development of appropriate benchmarks to measure each mutual fund. Douglas T. Breeden, chief investment officer, Smith Breeden, also now a professor at Duke University, calls Messrs. Scholes and Merton "grand figures of finance." His firm uses the model extensively, including in mortgage securities portfolios.
Mr. Merton showed the options pricing model had a broader application than Messrs. Scholes or Black originally thought, said Mr. Breeden.
"The model is useful even when one of its main assumptions is violated," Mr. Breeden said. "The Black-Scholes model assumes interest rates are constant. But if interest rates are constant, risk management in the bond market wouldn't be important. But Metton showed the model works very well even when interest rates aren't constant."
Work sparks a revolution
Jeffrey A. Geller, executive director, BEA Associates Inc., New York, said their options pricing work "revolutionized investment management. You can't think of a major market not affected by options theory."
Speaking of the options pricing model, GTE's Mr. deMarco said: "We use it to maintain historic time series on the richness or cheapness of options for strategies we use."