In the summer of 1968, a 24-year-old graduate student, the applied mathematician–turned–economist Robert C. Merton (son of the famous Columbia University sociologist Robert K. Merton) was talking with his professor and mentor Paul Samuelson, who would soon become the first American to win the Nobel Prize in Economics.
They sat in Samuelson’s office at MIT, which looked out over Memorial Drive to the Charles River Basin, dotted with sailboats, and then on beyond to the big city on the opposite shore. But neither one noticed the view, Samuelson because it was familiar, and Merton because he was focused instead on Samuelson, who started off the conversation with the words that ambitious graduate students dream of hearing,“Why don’t we write a paper together?”
The precipitating event for the suggestion seems to have been the publication in 1967 of Edward Thorp and Sheen Kassouf ’s Beat the Market, which purported to offer a scientific system for making money in the stock market by buying stock and at the same time selling short something called a “warrant” on the same stock.A warrant is a kind of stock option issued by a corporation that gives the holder the right to buy shares in the company at a specified price at any time up to a specified date in the future. In 1968 there was no organized options exchange, but there were over one hundred traded warrants.
Thorp and Kassouf claimed to have found a way to identify warrants that were overvalued, and to profit by setting up an arbitrage with the stock. In his review of their book, Samuelson had written:“Just as astronomers loathe astrology, scientists rightly resent vulgarization of their craft and false claims made on its behalf.
