Myron Scholes · Lablypedia

In 1997, Scholes was awarded the Nobel Memorial Prize in Economic Sciences (shared with Robert C. Merton) for a "new method to determine the value of derivatives." The Royal Swedish Academy of Sciences noted that their work made it possible to observe the value of options in a scientific manner, effectively creating a foundation for the rapid growth of financial markets and the management of economic risk across the globe.

Scholes is currently the Chief Investment Strategist at Janus Henderson. Previously he served as the chairman of Platinum Grove Asset Management and on the Dimensional Fund Advisors board of directors, American Century Mutual Fund board of directors, chairman of the Board of Economic Advisers of Stamos Capital Partners, and the Cutwater Advisory Board. He was a principal and limited partner at Long-Term Capital Management (LTCM), a highly leveraged hedge fund that collapsed in 1998, and a managing director at Salomon Brothers. Other positions Scholes held include the Edward Eagle brown Professor of Finance at the University of Chicago, senior research fellow at the Hoover Institution, director of the Center for Research in Security Prices, and professor of finance at MIT's Sloan School of Management. Scholes earned his PhD at the University of Chicago.

Biography

Early life and education

Scholes was born to a Jewish family on July 1, 1941, in Timmins, Ontario, where his family had moved during the Great Depression. In 1951 the family moved to Hamilton, Ontario. Scholes was a good student although fighting with his impaired vision starting with his teens until finally getting an operation when he was twenty-six. Through his family, he became interested in economics early, as he helped with his uncles' businesses and his parents helped him open an account for investing in the stock market while he was in high school.

After his mother died from cancer, Scholes remained in Hamilton for undergraduate studies and earned a Bachelor's degree in economics from McMaster University in 1962. One of his professors at McMaster introduced him to the works of George Stigler and Milton Friedman, two University of Chicago economists who would later both win Nobel prizes in economics. After receiving his B.A. he decided to enroll in graduate studies in economics at the University of Chicago. Here, Scholes was a colleague with Michael Jensen and Richard Roll, and he had the opportunity to study with Eugene Fama and Merton Miller, researchers who were developing the relatively new field of financial economics. He earned his MBA at the Booth School of Business in 1964 and his Ph.D. in 1969 with a dissertation written under the supervision of Eugene Fama and Merton Miller.

Academic career

In 1968, after finishing his dissertation, Scholes took an academic position at the MIT Sloan School of Management. Here he met Fischer Black, who was a consultant for Arthur D. Little at the time, and Robert C. Merton, who joined MIT in 1970. For the following years Scholes, Black and Merton undertook groundbreaking research in asset pricing, including the work on their famous option pricing model.

At the same time, Scholes continued collaborating with Merton Miller and Michael Jensen. In 1973 he decided to move to the University of Chicago Booth School of Business, looking forward to work closely with Eugene Fama, Merton Miller and Fischer Black, who had taken his first academic position at Chicago in 1972. While at Chicago, Scholes also started working closely with the Center for Research in Security Prices, helping to develop and analyze its famous database of high frequency stock market data.

In 1981 he moved to Stanford University, where he remained until he retired from teaching in 1996. Since then he holds the position of Frank E. Buck Professor of Finance Emeritus at Stanford. While at Stanford his research interest concentrated on the economics of investment banking and tax planning in corporate finance.

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Economic contributions

Theoretical Breakthrough: Solving the Warrant Problem (1973)

Prior to the 1973 publication of "The Pricing of Options and Corporate Liabilities," researchers struggled to value options because it was assumed the price depended on the expected return of the underlying stock. Scholes and Black's breakthrough was the realization that in a continuous-time market, a riskless hedge can be maintained between the option and the stock. This led to the "Risk-Neutral" insight: the expected return of the stock drops out of the equation, replaced by the risk-free rate.

The Black–Scholes Formula (1973)

Scholes is most famous for the Black–Scholes formula, which provides a theoretical estimate of the price of European-style options:

The Black–Scholes Formula

$C = S_{t} N (d_{1}) - K e^{- r (T - t)} N (d_{2})$

where

$d_{1} = \frac{\ln (S_{t} / K) + (r + \frac{σ^{2}}{2}) (T - t)}{σ \sqrt{T - t}}$
$d_{2} = d_{1} - σ \sqrt{T - t}$

Variable Definitions:

$C$ : Price of the call option (Value for the Buyer).
$S_{t}$ : Current price of the underlying stock (The "Plus" side asset).
$K$ : Strike price (The "Minus" side cost/debt to be paid).
$r$ : Risk-free interest rate.
$T - t$ : Time until expiration (in years).
$σ$ : Volatility of the stock returns.
$N (\cdot)$ : Cumulative normal distribution function.

This formula is considered revolutionary because it provided the first mathematically sound method to price financial risk; by treating a company's equity as an option on its total assets, it allowed for the systematic valuation of corporate debt and the assessment of credit risk.

Risk Management and "The Greeks" (1970s–1980s)

The Black–Scholes model allows for the calculation of "Greeks"—sensitivities that describe how the option's value changes with respect to different parameters.

Tax Planning: The Scholes–Wolfson Framework (1992)

Scholes is a pioneer in the field of tax strategy, co-developing the Scholes–Wolfson Framework with Mark A. Wolfson. This framework moved tax research from simple "tax avoidance" to a holistic "Global Tax Planning" theory used in modern corporate finance and accounting.

The framework is built on three pillars:

All Taxes: Planning must consider taxes at all levels (corporate, individual, and foreign).
All Parties: Transactions must be beneficial after considering the tax implications for both sides (contracting theory).
All Costs: Tax minimization is only optimal if the "non-tax costs" (like legal fees or financial reporting costs) do not outweigh the tax savings.

Investment activity

In 1990 Scholes became more involved directly with the financial markets. He went to Salomon Brothers as a special consultant, then becoming a managing director and co-head of its fixed-income-derivative group. In 1994 Scholes joined several colleagues, including John Meriwether, and his future Nobel Memorial Prize co-winner Robert C. Merton, and co-founded a hedge fund called Long-Term Capital Management (LTCM). The fund, which started operations with $1 billion of investor capital, performed extremely well in the first years, realizing annualized returns of over 40%. However, following the 1997 Asian financial crisis and the 1998 Russian financial crisis the highly leveraged fund in 1998 lost $4.6 billion in less than four months and collapsed abruptly.

LTCM brought legal problems for Scholes in 2005 in the case of Long-Term Capital Holdings v. United States. The firm's corporate structure and accounting had established an offshore tax shelter to avoid taxes on investment profits. Courts disallowed the firm's claim of $40 million in tax savings, finding it based on formal accounting losses of $106 million that represented no economic substance.