Book contents
- Frontmatter
- Contents
- Preface
- INTRODUCTION: INNOVATION IN LEGAL THINKING
- PART 1 PRINCIPLES
- PART 2 METHODS
- 7 MATHEMATICAL MODELING
- 8 CONFRONTING UNCERTAINTY: BASIC PROBABILITY THEORY
- 9 ADVANCED PROBABILITY: DISTRIBUTIONS AS THE SHAPE OF RANDOMNESS
- 10 HOW TO PRICE UNCERTAINTY: FINANCE
- 11 FINANCE AND PROBABILITY: OPTIONS AND DERIVATIVES
- 12 USING SPREADSHEETS
- 13 STATISTICS
- 14 CONCLUSION: IMPORTING METHODOLOGICAL INNOVATIONS
- APPENDIX A MEINHARD V. SALMON 249 N.Y. 458 (1928)
- APPENDIX B GLOSSARY
- APPENDIX C MATHEMATICA NOTEBOOKS
- Index
11 - FINANCE AND PROBABILITY: OPTIONS AND DERIVATIVES
Published online by Cambridge University Press: 24 July 2009
- Frontmatter
- Contents
- Preface
- INTRODUCTION: INNOVATION IN LEGAL THINKING
- PART 1 PRINCIPLES
- PART 2 METHODS
- 7 MATHEMATICAL MODELING
- 8 CONFRONTING UNCERTAINTY: BASIC PROBABILITY THEORY
- 9 ADVANCED PROBABILITY: DISTRIBUTIONS AS THE SHAPE OF RANDOMNESS
- 10 HOW TO PRICE UNCERTAINTY: FINANCE
- 11 FINANCE AND PROBABILITY: OPTIONS AND DERIVATIVES
- 12 USING SPREADSHEETS
- 13 STATISTICS
- 14 CONCLUSION: IMPORTING METHODOLOGICAL INNOVATIONS
- APPENDIX A MEINHARD V. SALMON 249 N.Y. 458 (1928)
- APPENDIX B GLOSSARY
- APPENDIX C MATHEMATICA NOTEBOOKS
- Index
Summary
Options are extraordinarily important because they capture the difference between obligation and freedom. Financial economists only recently developed the ability to quantify the effect of some options. This new ability to quantify options obviously has enormous value for legal analysis, because law focuses on obligations and freedoms.
Option theory presents a new aspect of Meinhard v. Salmon. Salmon received a lucrative offer from Gerry, a business acquaintance. The offer could have expanded Salmon's business. Unbeknownst to Gerry, Salmon's business, which was the reason for their acquaintance, had a secret partner, Meinhard. If Gerry knew that Salmon operated in two capacities, as an individual and as a member of a partnership, then Gerry may have specified which of the two he selected as the recipient of his offer. Meinhard, the invisible partner, claimed the offer should be treated as made to the partnership. The litigation that Meinhard started eventually reached the highest court of the jurisdiction, judge Benjamin Cardozo, and his dissenting colleague, Andrews. Previously established law did not answer the question directly. If Cardozo and his court had had a better handle on options they might have realized that participation in a subsequent venture was an option. Nowadays, such an option can be valued and similar “derivatives” are traded routinely in exchanges. Compared with the valuation of stocks, the valuation of derivatives is a simple application of probability theory. The premise, however, that simplifies the valuation of derivatives is solidly founded on economic or financial reasoning.
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- Chapter
- Information
- Principles and Methods of Law and EconomicsEnhancing Normative Analysis, pp. 225 - 248Publisher: Cambridge University PressPrint publication year: 2005