“Finance and Computer Intensive Models”
Myron S. Scholes, Ph.D.
1997 Nobel Laureate in Economic Sciences
Post-lecture discussion panelists: Professor Charles S. Tapiero, Morton L. Topfer Chair and Distinguished Professor of Financial Engineering and Technology Management, NYU-Poly; Joseph S. Steinberg, President, Leucadia National Corporation and Trustee, NYU and NYU-Poly; and William Ackman, President, Pershing Square Capital Management LP
Thirteenth Annual Lynford Lecture
Introductory Remarks by Jeffrey Lynford
April 20, 2011
Good afternoon, and thank you, Jeny, for your gracious introduction.
Today we have with us Professor Myron Samuel Scholes, the world-renowned economist and Nobel
Laureate. On December lOth, 1997 in Stockholm, the King of Sweden, on behalf of the Royal Swedish Academy of Sciences, presented to him and his colleague, Robert Merton, its Memorial Prize in Economic Sciences for their new work valuing options and derivatives.
Beginning in 1970 at MIT, these two economists, and a third colleague, named Fischer Black, began
working on option valuations and in 1973 The Black -Scholes formula for pricing stock options was
published. It was from and for this pioneering work that all binomial option models have evolved and
their Nobel Prize was awarded.
Professor Scholes earned his MBA in 1964 and PhD in 1969 from the University of Chicago in the relatively new field, at that time, of financial econonucs. In 1981 he joined the Economics Department faculty at Stanford University, taught there until 1996, and cunently he holds the position there of the Frank E. Buck Professor of Finance, Emeritus.
He is sometimes refened to as the "intellectual father of the credit-default swap," and his name and work often generates both admiration and controversy in various business and academic circles.
As you know "Finance and Computer Intensive Models" is the title of Professor Scholes' lecture this
afternoon. This is the perfect topic for us at IMAS and NYU-POLY for two reasons. First, the Professors Chudnovsky have spent the last several years conceiving and then writing the sophisticated algorithms necessary to suppor1 the development of "Cyclops," the world's fastest and most potent computer chip, now being produced by IBM. A machine built with these chips can perform at a rate of one peta-flop per second, which describes a speed per second equivalent to 1 with 15 zeroes following it.
Second, Professor Scholes' lecture is very appropriate for students at NYU-Poly, since Professor
Tapiero has assembled a fine faculty to teach many of the concepts that Professor Scholes will discuss today. Specifically, Professor Scholes' work relating to "Valuation and Managing under Uncertainty" is key to confronting systemic risk. If, as he believes, and I paraphrase, that the "only sustainable business model is intermediation and this will require computationally intensive business models," then both our students and faculty are well-positioned to play important roles in global finance and risk management in the years to come.
After the Professor speaks, we will be trying a new format for questions and answers. We have
assembled an impressive panel especially attuned to the theoretical and practical ramifications of
Professor Scholes' model including:
• NYU-POLY Distinguished Professor Charles Tapiero,
• NYU-POLY and NYU trustee, Joseph "Joe" Steinberg, who is also the President of Leucadia
National Corporation, which has been described as a "mini-Berkshire-Hathaway," and
• William "Bill" Ackman, a successful private equity fund manager and value-investor.
These three gentlemen have graciously agreed to participate on our panel after Professor Scholes' talk, and I will describe their careers, credentials and achievements in greater detail at the beginning of the Q&A.
We will also entertain questions from the audience. Please print legibly on the card we make available:
• your name,
• your affiliation with NYU-POLY or occupation, and
• your question.
Then hand this card directly to our audience ushers. They will be collected and we will read them to our guest lecturer as time permits. Then we will adjoum for refreshments and further conversation outside the auditorium.
Now, it is the time for me to request Professor Scholes, Professor David Chudnovsky and President
Hultin to come to the podium for the presentation of the IMAS plaque.
[Following Professor Scholes' lecture, the panelists assemble on stage]
Introduction of Panelists
As introduced earlier, our panelists include:
Professor Charles S. Tapiero, the Morton L. Topfer Chair and Distinguished Professor of Financial
Engineering and Technology Management at NYU-Poly. Professor Tapiero has published 12 books
and over 350 papers on a broad range of issues spanning financial and risk management, stochastic
modeling and applied stochastic control in technology, operations, insurance and finance. His books
include Applied Stochastic Models and Control in Finance and Insurance and Risk and Financial
Management: Mathematical and Computational Methods. He is the Co-Editor of Risk and Decision
Analysis as well as an Associate Editor and an Editorial Board member of several academic joumals.
Charles received a degree in electrical engineering from Ecole Polytechnique in Montreal and then his Master's and Ph.D. from NYU's Graduate School of Business.
May I see by a show of hands, how many students here are emolled in NYU-Poly's Financial
Engineering Program?
Mr. Joseph S. Steinberg, a trustee of both NYU and NYU-Poly, is the President of Leucadia National
Corporation, a NYSE-listed, investment holding company with a $9 billion market capitalization.
Through its subsidiaries, Leucadia engages in manufacturing, telecommunications, land-based contract oil and gas drilling, medical product development, gaming entertainment and many other businesses, including several in the financial services industry. In this sector, it is the largest shareholder in Jefferies Group, Inc., a full service global investment banking firm, and recently it formed Berkadia Commercial Mortgage LLC, a joint venture with Wanen Buffet's company, Berkshire Hathaway. Over the 32-year period between 1978 and 2010, Leucadia's market price has increased from $.01/share to $29.18/share at December 31, 2010, which represents a 28.3% CAGR. At the close of business on this past April 4th, its stock price reached slightly over $39/share, an extremely enviable record of market peiformance. Joe is an alum of NYU, eamed his MBA from Harvard Business School, and lives in Brooklyn within walking distance of our MetroTech campus.
Mr. William Ackman is the President of Pershing Square Capital Management LP, which he founded in
2003. Pershing is a deep value and activist-oriented fund manager. Prior to establishing Pershing Square, Mr. Ackman co-founded and ran Gotham Partners LP.
Bill, through his various funds, purchases shares in public companies which he believes are trading at a discount to full value and then sells them when they reach such value. Often, to accomplish his goals, he may advocate for changes in corporate management, seats on boards of directors, the sale of specific company assets or businesses, or the sale of the entire company.
In the past he has acquired positions in such household companies as Wendy's, McDonald's, JC Penney, Target, Borders, Bames & Noble and General Growth Properties. In the latter instance, Bill engineered the spin-off of the Howard Hughes Corporation, which holds many troubled real estate properties, including the South Street Seaport, here in NYC. This company, with a cunent enterprise value of $2.4 billion, came public last year in the mid $30s/share, and recently traded above $73/share. Through Pershing, Bill controls holds 9.5% of the Howard Hughes Corporation. Mr. Ackman is a magna cum laude graduate of Harvard, and also eamed his MBA from its business school.
There are several "points of intersection" among the panelists. In the spirit of full disclosure, Leucadia National Corporation was an investor in Pershing's initial investments. Also, Bill's prior investment vehicle, Gotham Partners, was shareholder in Wellsford Real Properties, a firm which I founded and served as Chairman. These two gentlemen are recognized by their peers as very savvy investment professionals and are among the smartest financiers I know. All three of us have utilized the Black-Scholes method of valuing options for many years, and I think believe in the late Princeton Professor Myron J. Levy's Fifth Law: "In unanimity there is cowardice and uncritical thinking."
Lastly, may I recommend that students of Financial Engineering read Joe Steinberg's annual "Letter to Shareholders," which may be found in the beginning of each of Leucadia's Annual Reports. Also, I
recommend Christine S. Richards's recent book about Bill Ackman's excruciatingly painful, but
ultimately successful, battle with MBIA, an insurance company which specialized in enhancing the credit of municipal bonds. Bill, for six years, from 2002 to 2008, was the lone voice in the public marketplace explaining how such mono-line insurers were overleveraged and thus not worthy of their triple AAA ratings. The title of this book is Confidence Game: How a Hedge Fund Manager Called Wall Street's Bluff and it makes fascinating reading. These letters and book contain excellent case studies in underwriting and share with the reader some of Steinberg's and Ackman's personal observations and experiences, which I believe have immeasurable value for students and professionals alike.
Question for Professor Scholes: This past Monday, Standard & Poors revised its rating outlook on U.S. debt from "stable downward" to "negative". This rating agency stated that its outlook reflects "at least a one-in-three likelihood" of a downgrade of our AAA rating in the next two years.
Assuming a downgrading of U.S. debt to AA+ or less, how will this impact your option valuation model, since one of the inputs in the model is the 10-year Treasury rate? Intuitively this would tend to dampen valuations. How do you see this downgrading actually impacting option values?