Who is Myron S. Scholes

Myron Scholes is a Canadian-American economist and co-originator of the Black-Scholes options pricing model. He was a key player in the collapse of Long-Term Capital Management, one of the biggest hedge fund disasters in history — just after he and Robert Merton were awarded the 1997 Nobel Prize in Economics for their work on options pricing.

BREAKING DOWN Myron S. Scholes

Myron Scholes is currently the chief investment strategist at Janus Henderson and serves on the board of the Chicago Mercantile Exchange. He is also the chairman of the Board of Economic Advisers of Stamos Capital Partners, and the Frank E. Buck Professor of Finance, Emeritus, at the Stanford Graduate School of Business.

The Origination of the Black-Scholes Model

After growing up in Hamilton, Ontario, and earning a BA in economics from McMaster University in 1962, Scholes earned an MBA and Ph.D. at the University of Chicago, where he was influenced by Eugene Fama and Merton Miller, trailblazers in the new field of financial economics.

In 1968, Scholes began teaching at the MIT Sloan School of Management, where he met Fischer Black, the co-author of the Black-Scholes equation, and Robert Merton. Together they would pursue groundbreaking research on options pricing, to which end Scholes returned to the University of Chicago in 1973 to work closely with Fama, Miller and Black. In In 1981 he moved to Stanford, where he remained until he retired from teaching in 1996.

Long-Term Capital Management and the Failure of Genius

Scholes became a managing director at Salomon Brothers in 1990, before making the fateful decision to join hedge fund Long Term Capital Management (LTCM), as a principal and co-founder. John Meriwether, the former head of bond trading at Salomon Brothers, had recruited Scholes and Merton, to give the firm credibility.

LTCM realized annualized returns of over 40% in the first three years — having placed large bets on the convergence of European interest rates within the European Monetary System — and by 1997 was cashing in on the prestige of Scholes' and Merton's Nobel Prizes. But pride cometh before a fall. LTCM's use of insane amounts of leverage – using debt and derivatives – without allowing for adverse movements in security prices, led to its spectacular and abrupt collapse in 1998, following the 1997 Asian financial crisis and the 1998 Russian financial crisis. When market volatility spiked, its huge directional bets on sovereign bonds blew up, and forced margin calls that presented such a systemic risk that the Federal Reserve had to intervene. The fund lost $4.6 billion and was liquidated in early 2000.

It was a salutary lesson on the limitations of value at risk (VaR), and the folly of placing blind faith in financial models. According to LTCM’s VaR model, the $1.7 billion it lost in August 1998 should only have occurred every 6.4 trillion years.