Fischer Black and the Revolutionary Idea of Finance

Mehrling, a monetary economist, wrote an intellectual biography of Fischer Black that is as much a history of modern finance as a life. Black co-authored the option pricing formula, worked at Arthur D. Little, taught at Chicago and MIT, and spent his last years at Goldman Sachs.

Mehrling's argument is that Black is misunderstood as a mathematician who produced a formula. Black's actual position was more radical: he took the capital asset pricing model as literally true and applied it to everything, including monetary policy, business cycles and international finance, which produced conclusions that neither Keynesians nor monetarists could accept. His monetary work argued that money is passive, that the quantity of money is determined by demand rather than by the central bank, and that a modern financial system with unrestricted banking would produce a price level indeterminate by any monetary aggregate. Almost nobody agreed and most of it was never published in mainstream journals.

The book also covers Black's paper on noise, which argued that markets need traders acting on noise for liquidity to exist, that prices are efficient only within a factor of two, and that most of what looks like information trading is not.

Mehrling is careful about the finance and about Black's disagreements with Fama, Merton and Samuelson. The book requires some familiarity with financial theory. Its value for investors is the account of what the capital asset pricing model implies if taken seriously, and Black's noise argument, which remains the most useful short statement of how efficiency and inefficiency coexist.