Watson, Matthew, Ph.D.. (2007) Searching for the Kuhnian moment : the Black-Scholes-Merton formula and the evolution of modern finance theory. Economy and Society, Vol.36 (No.2). pp. 325-337. ISSN 0308-5147

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Abstract

The Black-Scholes-Merton formula has been put to widespread use by options traders because it provides a means of calculating the theoretically 'correct' price of stock options. Traders can therefore see whether the market price of stock options undervalues or overvalues them compared with their hypothetical Black-Scholes-Merton price, before choosing to buy or sell options accordingly. As a consequence of this close relationship between options pricing theory and options pricing practice, a strong performativity loop was activated, whereby market prices quickly converged on the hypothetical Black-Scholes-Merton prices following the dissemination of the formula. The theory has therefore had significant real-world effects, but how should we characterize the initial instinct to derive the theory from a philosophy of science perspective? The two books under review suggest that a Kuhnian reading of the advancement of scientific knowledge might well be the most appropriate. But, on closer inspection, it becomes clear that the publication of the Black-Scholes-Merton formula should not be seen as a Kuhnian moment with paradigm-shaping attributes. It is shown that, at most, the formula acts as an important exemplar which, via its use in the training of options pricing theorists and options pricing practitioners, reinforces the entrenchment of finance theory within the orthodox economics worldview.

Item Type:	Journal Article
Subjects:	H Social Sciences > HG Finance
Divisions:	Faculty of Social Sciences > Politics and International Studies
Library of Congress Subject Headings (LCSH):	Options (Finance), Pricing, Differential equations, Partial, Paradigms (Social sciences)
Journal or Publication Title:	Economy and Society
Publisher:	Routledge
ISSN:	0308-5147
Date:	May 2007
Volume:	Vol.36
Number:	No.2
Page Range:	pp. 325-337
Identification Number:	10.1080/03085140701254340
Status:	Peer Reviewed
Access rights to Published version:	Open Access
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URI:	http://wrap.warwick.ac.uk/id/eprint/2130

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