Overview
Robert C. Merton (b. 1944) is John and Natty McArthur University Professor at Harvard Business School. His 1973 paper "Theory of Rational Option Pricing" — developed from sections of his MIT PhD dissertation (1970) and published in the same inaugural issue of the Bell Journal as his ICAPM — established both the rational restrictions framework for option pricing and an alternative derivation of the Black-Scholes formula under strictly weaker assumptions (stochastic interest rates allowed; CAPM not required). He was awarded the Nobel Prize in Economics in 1997 jointly with Myron Scholes; Fischer Black had died in August 1995 and was ineligible.
Key Contributions / Features
- Merton (1973): Complete set of model-free rational restrictions on option/warrant prices (Theorems 1–13); alternative B-S derivation under stochastic interest rates (eq. 38); extensions to dividends, the American perpetual put, down-and-out barrier options, and callable warrants. First closed-form barrier option formula in the literature.
- ICAPM (1973): Intertemporal CAPM; continuous-time portfolio theory with multiple state variables and hedging demands; published in the same Bell Journal issue as the option pricing paper.
- Merton (1974): Structural credit risk model treating corporate debt as options on firm value; direct extension of the corporate-liabilities-as-options framework from Black-Scholes (1973).
- Merton (1976): Jump-diffusion model; augments GBM with compound-Poisson jumps; see Jump-Diffusion Model.
- Nobel Prize in Economics 1997 jointly with Myron Scholes.
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