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. Last Updated: 07/27/2016

Creators of Stock Formula Win Nobel

STOCKHOLM, Sweden -- Two Americans won the Nobel Economics Prize on Tuesday for their work in figuring out how to evaluate the worth of stock options and other "derivatives'' that are a key element of today's booming markets.


The prize, worth 7.5 million kronor ($1 million), was awarded to Robert Merton of Harvard University and Myron Scholes of Stanford University.


Thousands of traders and investors now use the formula, which dates back to 1973, according to the Swedish Academy of Sciences, which chooses the winner of the annual prize.


"I was just thrilled and I couldn't believe it,'' Merton told CBS radio after winning the prize. "I had to sort of check if it was a dream or something.''


Scholes, who has a home in Greenwich, Connecticut, and works in California, could not immediately be reached.


In contrast to the highly theoretical bent of many previous economics prizes, this year's award has clear day-to-day applications.


The academy said the work had laid the foundation for the rapid growth of markets for derivatives in the last 10 years.


"The method has created new areas of research, inside as well as outside of financial economics. A similar method may be used to value insurance contracts and guarantees, or the flexibility of physical investment projects,'' the academy's citation said.


"If you ask what idea in the last 50 or 60 years coming from economic research has had the biggest impact on the world, this is it,'' said Avainash Dixit, an economics professor at Princeton. "It's changed the way the financial markets ... allocate risks among different types of investors.''


In purchasing derivatives, investors are not buying a stock but a financial instrument connected to a stock. For instance, purchasing a so-called "call option'' gives the buyer the right to purchase a stock at a certain price at a certain time; the investor takes the risk of betting that the stock will be worth more than the set price on that date.


Because the derivatives are not stocks, their value is somewhat abstract. One of the formulas developed by the winners, for instance, attempts to place a value on a call option by considering such factors as current interest rates, how much the stock has fluctuated and the probability that the option will be exercised.


Scholes originally developed the theory working with Fischer Black, who died in 1995. Merton helped elaborate the work to make it more broadly applicable.


The economics prize is the newest of the Nobels. It is not one of the original five created by Nobel, the inventor of dynamite who endowed the prizes in his will. The Swedish Central Bank persuaded the Nobel Foundation in 1968 to let it endow the award.


It is the fourth of the prizes to be awarded this year.