Academic research has made remarkable contributions to our knowledge as to how capital markets behave. This research has in turn stimulated changes in the practise of finance. From the seminal contributions of Markowitz (1952) and subsequently Sharpe (1964) we have learnt how diversification affects the risk of holding securities. This has stimulated practical innovations in index funds, risk and style based bench‐marking of portfolio performance as well as more precise methods for estimating capital costs. From the contributions of Black and Scholes (1973) we have also learnt how financial and real options can be valued. This in turn provided the necessary condition for the development of the huge market in derivative securities. Who could have issued LYONS, Nikkei puts, bull floaters and caps and collars if Black and Scholes had not first made the key insight that you could value these securities indirectly by creating a risk free portfolio? Finally, from Jensen and Meckling (1976) we have rediscovered the problems of incentive structures, and the importance of “agency” problems. This in turn has stimulated significant changes in the design of financial securities, such as event risk clauses in bonds, to protect against corporate opportunism, as well as providing the intellectual motivation behind the dramatic developments in management and leveraged buyouts. The above developments have been recognised in two Nobel prizes with most probably more to come.
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