A theorist’s trading failure can vindicate a pricing model

Evidence

Another facet of ambivalence is, however, present here too. The failure to profit from National General warrants might have been a private disappointment, but there was a sense in which it was a vindication of market efficiency: an apparent profit opportunity turned out not to be real, because market prices were incorporating a piece of information that was not known to Black and his colleagues. `Although our trading didn’t turn out very well, this event helped validate the [Black-Scholes] formula,” wrote Black: “The market price was out of line for a very good reason” (Black 1989, p. 7). Paradoxically, theorists’ practical failure could thus be cited as evidence of theory’s robustness. — Donald MacKenzie, An Engine, Not a Camera, 1119

Categorization

• SEED: The paradox that practical failure supports theory could anchor an essay on how evidence and self-interest invert in finance theory practice.
• XREF: connects to: Even legendary arbitrageur Thorp’s own trader balked at exploiting the crash’s price gap — Donald MacKenzie, An Engine, Not a Camera: How Financial…, 829; Empirical trading experience can block acceptance of a theory’s core assumptions. — Donald MacKenzie, An Engine, Not a Camera: How Financial…, 1106; Most finance theorists’ own trading contradicted strict market efficiency. — Donald MacKenzie, An Engine, Not a Camera: How Financial…, 1114 (+3 more)

Broader Connections

• Economic theory succeeded in derivatives markets partly by making markets conform to it #exemplifies (0.75) — Donald MacKenzie & Yuval Millo, Constructing a Market, Performing Theory, 9
• Option pricing theory did not describe markets but remade them in its own image #expands (0.72) — Donald MacKenzie & Yuval Millo, Constructing a Market, Performing Theory, 182