Robert C. Merton

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This article is about the economist. For the sociologist, see Robert K. Merton.

Robert C. Merton (born July 31, 1944), is a leading scholar in the field of finance and was one of three men who, in the early 1970s, developed the mathematics of financial options. Merton was the first to publish a paper expanding our mathematical understanding of the options pricing model and coined the term "Black-Scholes" options pricing model, by enhancing work that was published by Fischer Black and Myron S. Scholes. Merton authored a paper entitled "The Theory of Rational Option Pricing" which was published the Bell Journal of Economics and Management in the spring of 1973. It is somewhat unfair to Merton that the resulting formula has ever since been known as Black-Scholes, but with another hyphen the label would be unwieldy.

Merton is credited with bringing academia, specifically finance and mathematics professors, to Wall Street. His Wall Street career began at Salomon Brothers in the 1980's and continued into the following century when he was a Managing Director at JP Morgan.

Merton obtained his PhD in Economics from MIT in 1970, where, studying under Nobel Laureate Paul Samuelson, he helped introduce stochastic calculus into financial economics, allowing the behavior of prices to be described in the precise language of probability. He then applied optimal control theory in order to derive consumption and portfolio allocation rules for economically optimizing agents (see Merton's portfolio problem), and his work has paved the way for the now flourishing field of financial engineering, and quantitative finance which applies his methods to calculate prices for exotic derivatives with arbitrary payoffs.

In 1969 Merton published ground breaking work on a dilemma that all investors face. Merton's portfolio problem enables people to decide how much of their income they can consume now and of the remaining income, how much of it should be allocated between stocks and bonds to maximize the usefulness of that income.

In 1970 Merton introduced a structural credit risk model. The 'Merton Model' refers to a model that treats equity as an option on the firm's assets. Simply consider equity a call option, the total liabilities the strike price, and the value of the firm's assets the value of the underlying asset. This makes sense theoretically because equity is a residual: equity holders get the upside if things go well, but nothing if things go poorly. A popular commercial version of the Merton Model, the KMV Model, is now widely used.

In 1973 Merton introduced the Intertemporal Capital Asset Pricing Model known as ICAPM. ICAPM incorporates explicit hedges that investors make to protect themselves from savings shortfalls or changes in the investment opportunity set.

In 1997 Merton and Scholes were awarded the Nobel Memorial Prize in Economics for their work on stock options. Fischer Black had already passed away or he would have shared in the prize as well. Given the impact of their work, many believed the prize was long over due.

In 1999 Merton was awarded the lifetime achievement award in mathematical finance.[1]

In 2002 Merton threw himself into the public controversy over how corporations ought to account for the stock options they often award as parts of a compensation package. At that time, accounting rules did not require that options be treated as expenses when issued, and some economists suspected that the practice of keeping this particular form of compensation off the balance sheet contributed to the 1990s bubble in the value of dot-coms and telecoms. Merton himself was among the advocates of expensing stock options. Shortly after Merton advocated expensing options, the FASB changed their rules and began to require expensing options.

In 2005 the Baker Library at Harvard University opened The Merton Exhibit[2] to honor his lifelong achievements and inspire students to pursue academic careers.

In 2006, recognizing the pension crisis, Merton developed SmartNest, a pension management solution that addresses deficiencies associated with traditional defined-benefit and defined-contribution plans.

In 2007 Merton was tapped as Chief Science Officer at Trinsum Group. Trinsum integrates advisory services previously accessible only through the use of multiple providers filling the gap between management consulting and investment banking for objective, real-world advice steeped in financial science. Merton refers to this as "Functional and Structural Finance".

Family of Scientists Merton is also the son of Robert K. Merton, a distinguished sociologist at Columbia University perhaps best known for having coined the phrase "self-fulfilling prophecy."

Personal Life Merton was born in New York, New York and received his Bachelor of Science degree in Engineering Mathematics from the School of Engineering and Applied Science of Columbia University.[3] He then entered the Ph.D. program in Applied Mathematics from Caltech from 1966-1967, and picked up an M.S. there, but then transferred to the Ph.D. program in Economics at MIT. [4]. After receiving his Ph.D. from MIT under the guidance of renowned economist Paul Samuelson, Merton joined the faculty at the MIT Sloan School of Management.

Currently, Merton is a professor at the Harvard Business School; he also holds the rank of University Professor, which is the highest professorial rank at Harvard University.

[edit] See also

• Robert Merton's homepage at the Harvard Business School
• List of economists
• new method to determine the value of derivatives.
• List of personalities associated with Wall Street.

[edit] Documentary

Nova - Trillion Dollar Bet (1999)