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John Cox: Master Modeler

By Nina Mehta

In mid-September, John Cox, a grand master in derivatives pricing theory, received the sixth annual IAFE/Infinity Financial Engineer of the Year award. Previous winners are Robert Merton, Fischer Black, Mark Rubinstein, Stephen Ross and Robert Jarrow.

Cox, the Nomura Professor of Finance at MIT, received the award for “significant contributions in the development of financial engineering technology,” according to Stephen Ross, chairman of the selection committee. The star-studded committee, composed of senior fellows at the International Association of Financial Engineers, included seven Nobel laureates in economics. SunGard’s Infinity, the prize’s cosponsor, presented Cox with the $10,000 prize at the annual IAFE conference in September.

Since earning a Ph.D. in 1975 from the Wharton School at the University of Pennsylvania, Cox has rolled back the boundaries of what is calculable in a number of areas in financial economics. He is perhaps best known as one of the developers of the Cox-Ross-Rubinstein binomial model for pricing options, which built on earlier work on Poisson models by Cox and Ross, and the Cox-Ingersoll-Ross model for the term structure of interest rates.

The Cox-Ross-Rubinstein binomial model was developed in 1976, three years after the Black-Scholes-Merton model. Its strengths were its relative simplicity, its flexibility, and the fact that it permitted the pricing of American as well as European options (Black-Scholes-Merton wasn’t able to provide fair values for options that could be exercised before expiry). The new model, says John Marshall, IAFE’s departing executive director, became the “prototype for a whole class of binomial and multinomial models—often referred to as lattice trees—that developed later on.”

What made the Cox-Ross-Rubinstein model possible in the first place was the recognition that investor risk preferences played no part in the pricing of derivatives. This concept of risk-neutral pricing, first stated by Cox and Ross, ultimately “gave rise to a better understanding of how derivative securities are priced by opening up the mathematics of derivative securities to a wide audience,” says Alan Tucker, coeditor of IAFE’s Journal of Financial Engineering. “It raised comfort levels and modernized pricing in the industry.”

The discovery of risk-neutral pricing and the Cox-Ross-Rubinstein model led—not surprisingly—to a boomlet in the publishing industry for textbooks explaining how to price derivatives. Computational alternatives to the Cox-Ross-Rubinstein model now exist, and the textbook that Cox and Mark Rubinstein wrote in 1985—the first textbook, says Cox, “and the one whose existence spurred the way for the creation of a lot of dedicated courses on options in universities around the country”—has been superseded by others, but the model is still used because of its ease and value as a teaching tool.

In the mid-1970s, Cox and Ross went on to publish a number of papers with Jon Ingersoll of Yale University. The Cox-Ingersoll-Ross term-structure model, developed in the mid-1970s and published in 1985, provided a consistent way to value interest rate derivatives.

Cox has left his fingerprints in other areas of financial economics as well. In a 1981 article, he showed that forward and futures prices will not necessarily be identical—an idea that flew in the face of Street wisdom. A 1976 paper, written with Fischer Black, examined some of the ways that bond provisions could bring about a firm’s bankruptcy or reoganization. That paper is now attracting renewed interest because it was one of the first to deal with default premiums and credit spreads. In the late 1980s, Cox solved a long-standing problem in portfolio theory with Chi-fu Huang.

Cox, now 54, says that he was drawn to financial economics over the years because of the discipline’s intellectual challenges. “These were problems I liked to work on and think about,” he says, “although at the time I didn’t know what practical importance or lack thereof they might have.” He entered the field, he adds, “at an ideal time, because the scientific foundation had already been laid in critical developments in the 1960s and early 1970s that turned finance from a collection of anecdotes to a systematic approach to problems.”

So far, since the field’s early years, Cox’s tour of duty seems to have been an extremely productive and rewading one.


Briefly
  • Ezra Zask has been named principal and manager of the East Coast office of CP Risk Management. He served previously as president of Ezra Zask Associates.
  • SunGard has promoted Cristobal Conde to executive vice president, and Phillip Dowd and Michael Muratore to senior vice presidents.
  • Sam Alexander has been named director of Swiss Re New Markets. He had served as managing director at Aon Capital Markets in London. Swiss Re also named Joseph Hissong director of the client services group. Hissong had served as a partner at LeBoeuf, Lamb, Green & MacRae.
  • Hal Hansen, former president of Cargill Investor Services, has formed Viking Investors Services in Lake Forest, Ill.
  • Principia Partners has named Sean Togher director of product management. He previously served as a senior executive at Renaissance Software.
  • Richard Dodd has joined NeoVision Hypersystems as senior vice president of sales and marketing. He had served in various senior executive capacities at Infinity Financial Technology.
  • Rand Financial Services promoted Raymond Horn to chief executive officer.
  • The Philadelphia Stock Exchange has promoted Ken Meadon to senior vice president and chief regulatory officer, and named Adrienne Hart vice president of market surveillance. Hart had served as vice president and sales and training manager at CoreStates Financial Corp.
  • The Board of Trade Clearing Corp. has promoted Thomas Hammond to senior vice president of clearing services.
  • The Chicago Board of Trade has promoted Clifford Lewis to senior vice president of strategic planning, Kathryn Trkla to senior vice president and associate general counsel, and Jill Harley to vice president/treasurer.
  • The Cantor Exchange has named Susan Phillips, dean and professor of finance at George Washington University’s School of Business and Public Management, its first public director.
  • Catherine Morley has been named principal consultant in TCA Consulting’s risk practice. She had served as a manager in the group treasury at HSBC Holdings.
  • Michael May has been named senior manager for institutional marketing at GNI. He had served as head of structured products sales at Nationsbank in London.
  • Robert Palache has been appointed joint head of securitization at Nomura in London. He had served as managing partner at the financial practice of Clifford Chance.
  • Tim Batho has left Legal & General to join BT Alex Brown as head of equity derivatives.
  • Fimat has named Lucasz Cianciara director of its global credit derivatives group. He had served as vice president in Sumitomo’s credit derivatives group.
  • Sheldon Sussman, former director in Deutsche Securities’ credit derivatives group, has been named head of Rabobank International’s New York credit derivatives desk.
  • Sumitomo Capital Markets has named Barry Sherman head of short-term trading. He had served as executive director at CIBC Wood Gundy.
  • SS&C Technologies has promoted Gregory Reid to vice president of its financial services analytics group, from vice president of intellectual capital.
  • Larry Dickstein, a former manager at Citibank’s worldwide securities network, has been named head of Wilco International’s U.S. business consultancy.
  • Deutsche Bank has named David Battle, former head of global sales at Rolfe & Nolan, head of marketing for its global exchange services group.

Errata
In “Price Spike” (August), we inadvertently swapped the photographs of Paul Messerschmidt, manager of power markets services at Energy Security Analysis, and Rusty Braziel, chairman of Altra Energy Technologies. We apologize for the error.

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