Myron Scholes

Myron Scholes is a Canadian-American economist, born in Timmins, Ontario in 1941. Scarring on his corneas left him with poor sight through his school years, and he has said it pushed him toward listening and reasoning rather than reading, until surgery corrected it when he was in his twenties. He studied at McMaster University and then at the University of Chicago, completing a doctorate in 1969 under Eugene Fama and Merton Miller.

He joined the Massachusetts Institute of Technology in 1968, which is where he worked alongside Fischer Black and Robert Merton. The paper he wrote with Black, The Pricing of Options and Corporate Liabilities, appeared in the Journal of Political Economy in 1973 after being turned down by other journals; Merton published a related derivation the same year. Scholes returned to Chicago in 1973 and moved to the Stanford Graduate School of Business in 1983.

In 1997 he received the Nobel Memorial Prize in Economic Sciences jointly with Robert Merton, for a new method of determining the value of derivatives. The Academy noted Fischer Black's contribution and that he had passed away two years earlier.

The following year supplied the part of his record investors study most closely. He was a principal in Long-Term Capital Management, a fund founded in 1994 whose partners included Merton and some of the most accomplished traders of the period. Its positions were built on relationships between securities that historical data showed to be reliable, held at very high leverage. After Russia defaulted on domestic debt in August 1998, those relationships moved together rather than independently, and the fund lost the great majority of its capital within weeks. In September a recapitalisation organised by the Federal Reserve Bank of New York among fourteen institutions took over the positions and wound them down. He later led Platinum Grove Asset Management and has served as chief investment strategist at Janus Henderson.

The contribution Scholes shares with Black is a way of valuing a contingent claim without forecasting anything. If an option can be offset continuously with the underlying share so that the combined position carries no risk, then that combination must earn the risk-free rate, and that requirement is sufficient to pin the option's price. The consequence people found hardest to accept was that the expected return on the share plays no part: two investors who disagree completely about where a share is going must still agree on what its option is worth.

That result reframes what a derivative is. It is not a bet layered on top of a security but a position that can, in principle, be manufactured out of the security itself plus borrowing. Everything that followed, from hedging desks to structured products, rests on that equivalence holding closely enough in practice.

The 1998 episode is where the practical limits appear, and it is more instructive than the formula. The positions were not reckless directional bets; they were spreads between closely related securities, sized on historical evidence about how such spreads behave. Two assumptions failed together. Relationships that had been independent became correlated when many participants needed to sell the same things at once, and leverage meant the fund could not wait for the relationships to reassert themselves. A model can be right about the long run and still be irrelevant to a firm that has to survive the interval.

The general lesson investors take from it is about the interaction rather than either part alone. Precise measurement of risk tends to justify larger positions, because the measured risk looks small. Leverage then removes the ability to be wrong temporarily. The combination is what turns an accurate model into a solvency problem, and no improvement in the model addresses it.

Options pricing made a market possible. The Chicago Board Options Exchange opened the year the paper appeared, and the framework became the shared language in which derivatives are quoted, hedged and regulated.

The Long-Term Capital Management episode is taught more widely than the formula. It is the reference case for model risk, for correlations converging under stress, and for the specific danger of combining accurate measurement with high leverage.

The 1998 recapitalisation also shaped how authorities think about a single fund's failure spilling into the wider system, an argument that returned with force a decade later.