Myron Scholes, a Nobel laureate renowned for his research on the impact of uncertainty on asset prices, has significantly advanced our knowledge of financial markets. He is best known for his groundbreaking work with Fischer Black in the creation of the Black–Scholes options pricing model, which has fundamentally changed the landscape for investment professionals.
Despite his stature as one of the most influential living economists, Scholes continues to push the boundaries of financial market research. His current focus includes exploring the relationships between artificial intelligence (AI), carbon credits, and options, among other topics. Most recently, he participated in a fireside chat organized by Janus Henderson, hosted by CFA Society Hong Kong, and moderated by Alvin Ho, PhD, CFA, on 3 July 2023 in Hong Kong.
The Black–Scholes Revolution
CFA Society Hong Kong: It’s been 50 years since the publication of the Black–Scholes model, and it remains a widely studied and respected framework. What are your thoughts on its continued relevance?
Myron Scholes: The Black–Scholes model revolutionized the banking landscape by providing a means to price options. The ability to deal with uncertainty and risk is essential in an ever-changing world, making options a valuable tool for businesses and investors. The options market allows for a crowd-sourcing approach to understanding risk levels and supporting decision-making.
Decarbonization and Portfolio Construction
As we consider your work in decarbonization and portfolio theory, how does the options market play a role in this space?
Myron Scholes: My risk–return portfolio theory emphasizes the importance of understanding constraints and leveraging options to address these constraints. The goal is to smooth volatility and improve compounded returns. When applied to decarbonization, the focus shifts to creating more pathways toward achieving environmental goals, similar to the concept of a put option.
Regarding carbon credits, market efficiency remains key in determining fair value. The quality of the carbon credit is important, and a system is needed to separate good and bad credits. I view carbon credits as a commodity, and they should be commoditized in the market.
Portfolio managers can use a mechanism for individual choice to separate the challenges of portfolio management and decarbonization. This allows for efficient decision-making and scale.
Similarly, the trading and retirement of carbon credits offer different approaches to addressing environmental conservation. Both methods can contribute to achieving decarbonization goals, and advisory support can help smaller companies participate in these efforts.
Three Fallacies of Data Mining and AI
With the rise of private markets and the increased use of modern technology for data analysis, what are your thoughts on the role of big data and AI in addressing industry challenges?
Myron Scholes: Three fallacies in the industry, including the problem of data mining, must be considered. The limited perspective of current knowledge calls for regenerative AI to analyze the past more efficiently. Future generations can benefit from technological advancements to utilize time effectively and gain new perspectives.
Continued advancements in financial research and technological innovation are essential to navigating the complexities of global markets. Myron Scholes’ continued contributions and insights shed light on the ever-changing dynamics of the financial world.