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Robert C. Merton

Who is ‘Robert C. Merton’

Robert C. Merton is an American economist who won the 1997 Nobel Memorial Prize in Economic Sciences. Merton, along with Fisher Black and Myron Scholes, developed a method of determining the value of options, referred to as the Black-Scholes model. 

Merton also developed an intertemporal capital asset pricing model based on William Sharpe’s capital asset pricing model. CAPM is a way of calculating anticipated investment returns based on the level of risk.

BREAKING DOWN ‘Robert C. Merton’

Robert C. Merton is best known for the Black-Scholes model, also known as the Black-Scholes-Merton model. The Black-Scholes model is a model of price variation of financial instruments such as stocks. In one of the most important concepts in modern economic theory, Merton, along with his colleagues, developed the 1973 model.

Merton received the Nobel Prize in Economics in 1997 for his work on the Black-Scholes model. The model remains prevalent and influential. It is widely used today by investment bankers and hedge funds as the basis for hedging strategies. The Black-Scholes model is regarded as one of the best ways of determining the fair price of options.

The model is useful to determine the price of a European-style call option. When applied to a stock option, the model incorporates the constant price variation of the stock, the time value of money, the option’s strike price and the time to the option’s expiration. Execution of a European-style option is only upon the specified date.

The Black-Scholes model requires five input variables to complete the calculation. Input includes the option’s strike price, the current stock price, the time to expiration, the risk-free rate, and the volatility. Additionally, the model assumes stock prices follow a log-normal distribution because asset prices cannot be negative. The model further posits there are no transaction costs or taxes, the risk-free interest rate is constant for all maturities, short selling of securities with use of proceeds is permitted, and there are no riskless arbitrage opportunities. Contemporary models often differ, however, allowing for transaction costs and other variants.

Personal Life of Robert C. Merton

Merton was born in 1944 in New York City and grew up in Westchester County, New York. He has a Bachelor of Science in Engineering Mathematics from Columbia University, a Masters of Science from the California Institute of Technology, and a doctorate from Massachusetts Institute of Technology (MIT), where he studied under Paul Samuelson, considered one of the most influential economists of the 20th century.

Merton continued at MIT as a professor, teaching there for nearly two decades, then teaching at Harvard University for another 20 years. He has since returned to MIT, where he is Professor Emeritus.

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