An Equation and its Worlds

Abstract

This paper describes and analyses the history of the fundamental equation of modern financial economics: the Black-Scholes (or Black-Scholes-Merton) option pricing equation. In that history, several themes of potentially general importance are revealed. First, the key mathematical work was not rule-following but bricolage, creative tinkering. Second, it was, however, bricolage guided by the goal of finding a solution to the problem of option pricing analogous to existing exemplary solutions, notably the Capital Asset Pricing Model, which had successfully been applied to stock prices. Third, the central strands of work on option pricing, although all recognizably ‘orthodox’ economics, were not unitary. There was significant theoretical disagreement amongst the pioneers of option pricing theory; this disagreement, paradoxically, turns out to be a strength of the theory. Fourth, option pricing theory has been performative. Rather than simply describing a preexisting empirical state of affairs, it altered the world, in general in a way that made itself more true.