ABOUT THIS BOOK
Derivatives were responsible for one of the worst financial meltdowns in history, one from which we have not yet fully recovered. However, they are likewise capable of generating some of the most incredible wealth we have ever seen. This book asks how we might ensure the latter while avoiding the former. Looking past the usual arguments for the regulation or abolition of derivative finance, it asks a more probing question: what kinds of social institutions and policies would we need to put in place to both avail ourselves of the derivative’s wealth production and make sure that production benefits all of us?
To answer that question, the contributors to this book draw upon their deep backgrounds in finance, social science, art, and the humanities to create a new way of understanding derivative finance that does justice to its social and cultural dimensions. They offer a two-pronged analysis. First, they develop a social understanding of the derivative that casts it in the light of anthropological concepts such as the gift, ritual, play, dividuality, and performativity. Second, they develop a derivative understanding of the social, using financial concepts such as risk, hedging, optionality, and arbitrage to uncover new dimensions of contemporary social reality. In doing so, they construct a necessary, renewed vision of derivative finance as a deeply embedded aspect not just of our economics but our culture.
REVIEWS
“Derivatives have been a transformative financial innovation but have multiplied risks and complexities. Lee and Martin make an important contribution tracing the history of derivatives, how they work, and why they are important beyond technical finance.”
— Craig Calhoun, director, London School of Economics
“The idea that financial derivatives can be used to reveal new ways of framing social wealth and struggles over the distribution of that wealth is as inspired as it will be controversial. This collection of exceptional scholars from diverse disciplines may well be turning the study of finance and social change on its head.”
— Dick Bryan, coauthor of Capitalism with Derivatives
“A very ambitious effort to not only understand the derivative logic of financial markets through concepts of anthropology, sociology, and philosophy but also to understand the social through the logic of the derivative. It stands out not only as a truly interdisciplinary engagement with finance but also as a reversal through which derivative logic itself is used as a theory reflecting back on the social, which allows the authors to arrive at new and curious insights into their ‘native’ disciplines. The book strikes a rare balance as a critical engagement with finance and derivatives while at the same time not simply dismissing these as just another element of ‘evil capitalism.’”
— Ole Bjerg, author of Making Money and Parallax of Growth
"Eight papers present the case for an integration of the social and technical understanding of derivative finance within a single analytic and interpretive frame and use what was disclosed by the global financial crisis to show how technical knowledge of derivative finance can create a single coherent interpretive and analytic language of human possibility and well-being."
— Journal of Economic Literature
TABLE OF CONTENTS
Contributors
Preface
Introduction - Benjamin Lee
DOI: 10.7208/chicago/9780226392974.003.0001
[gift;ritual;play;performativity;volatility;convexity;uncertainty;hedging;arbitrage;Black-Scholes]
The Introduction provides the framework for reading the book, which shows how the “derivative reading of the social” and “the social reading of the derivative” are intertwined. The chapters by Arjun Appadurai, Edward LiPuma, and Benjamin Lee construct a social reading of the derivative by showing the interchangeability of gift and contingent claim. Robert Meister and Randy Martin trace the role of finance in Marxist accounts of capital, while Emanuel Derman, Elie Ayache, and Robert Wosnitzer draw upon their professional experiences as quants and traders to show both the technical side of Black-Scholes and the embodied side of market-making. (pages 1 - 14)
This chapter is available at:
University of Chicago Press
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Part I
1. The Wealth of Dividuals - Arjun Appadurai
DOI: 10.7208/chicago/9780226392974.003.0002
[individual;dividual;gift;ritual;performativity;predatory dividuation;backwardation;hau]
This chapter by the anthropologist Arjun Appadurai analyzes derivatives through a reconsideration of the “individual” in economic and political theory. Drawing upon anthropological research of Marcel Mauss and McKim Marriott, Appadurai introduces the concept of the “dividual” and argues that financialization produces “dividual” forms that “slice and dice” people into quantified risk categories that are held together by their relationship to risk and uncertainty. His example is that of the subprime mortgage crisis, which he compares to the processes of ritual dividuation in South Asia and Melanesia. Such ritual dividuation (without the monetary exploitation characteristic of capitalism) occurs through a process of “retro-performativity,” which creates dynamic assemblages of people connected by shared sensibilities that are created by ritual; Appadurai argues that similar processes of “dividuation” lie in the “risking together” characteristic of contemporary derivative capitalism. The chapter concludes with an example of a “dividual” social movement among slum dwellers in Mumbai, which is focused on how activities such as toilet festivals turn a negative value (shit) into a positive social value (solidarity). Appadurai suggests that the politics of the derivative and the dividual offers an alternative way that finance could be harnessed for the purposes of social justice. (pages 17 - 36)
This chapter is available at:
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2. Ritual in Financial Life - Edward LiPuma
DOI: 10.7208/chicago/9780226392974.003.0003
[circulation;performativity;constitutive;Black-Scholes equation;market;arbitrage;liquidity;counterparty;backwardation;left-handed equation]
Edward LiPuma’s chapter, “Ritual in Financial Life”, examines the implications of the analysis of ritual and exchange for our understanding of derivative finance. He looks at both ritual exchange and derivatives in terms of circulation and traces the rituality of “primitive exchange” to the forms of rituality constitutive of financial markets. Drawing upon Donald Mckenzie’s work on the performativity of finance, LiPuma places performativity in the context in which it first arose in anthropology—the analysis of ritual—and shows how the various forms of ritual performativity—“type-token,” “constitutive,” “citational,” and “pragmatic”-- work in contemporary finance to constitute what we know as “the market.” LiPuma then turns from the performative constitution of derivatives markets to an analysis of the Black-Scholes equation and its use in creating liquidity. He shows the contrast between how Black-Scholes is understood theoretically and how it is socially used, and the processes by which derivative finance objectifies its own practice, an objectification that is integral to its functioning and “success.” (pages 37 - 81)
This chapter is available at:
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3. From Primitives to Derivatives - Benjamin Lee
DOI: 10.7208/chicago/9780226392974.003.0004
[arbitrage;extension;volatility;calibration;replication;risk;noise;uncertainty;ritual;fetish]
“From Primitives to Derivatives” continues the social reading of the derivative initiated by Appadurai and LiPuma’s chapters and initiates a derivative reading of the social by introducing the notions of risk, uncertainty, and arbitrage, to the discussions of social and cultural figurers such as Max Weber, Clifford Geertz, and Jacques Derrida. The chapter opens with Emanuel Derman and Elie Ayache’s criticisms about the “physics of finance” model that is dominant among financial practitioners and the implications of the development of “implied volatility.” Implied volatility is the most popular use of the Black-Scholes model yet its results contradict the presuppositions of the model, and leading to the phenomenon of the “volatility smile” and supporting Donald Mackenzie’s performativity of finance thesis. Lee draws connections between LiPuma’s work on ritual performativity and Frank Knight and Fischer Black on risk, uncertainty, and noise, culminating in a reworking of Clifford Geertz’s famous analysis of the Balinese cockfight as a “Balinese delta-hedge” in which the Balinese actively cultivate uncertainty to create meaning. This leads to an analysis of Derrida’s “impossibility of the gift” as philosophical precursor of Weber’s Protestant Ethic in which decision-making under existential uncertainty paves the way for forms of subjectivity in contemporary capitalism. (pages 82 - 140)
This chapter is available at:
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Part II
4. Liquidity - Robert Meister
DOI: 10.7208/chicago/9780226392974.003.0005
[choke points;general strike;financial accumulation;liquidity;surplus value;debt;equity;puts;calls;parity]
Meister looks at Mitchell’s Carbon Democracy and the problem of “choke points” in capitalism. Meister provides a historical perspective on the development of “derivative capitalism," comparing it to the political opportunities provided by coal (the “general strike”) and oil economies (sabotage and terrorism). The turning point is the technologies of financial accumulation that allow people to store value in forms easily convertible into money. Derivatives become a new way to store wealth in which the Black-Scholes model for pricing becomes a way to create financial assets that parallels the capitalist mode of producing commodities. Meister then shows how finance is implicitly embedded in Marx’s account of capital and the “realization problem,” which can be solved if one considers the capitalist’s portfolio to consist of puts and calls in addition to debt and equity. The “put-call parity” also makes it possible to produce liquidity by setting the price that non-monetary assets can be converted into money, with the government being the lender of last resort.. The bailout shows that contemporary capitalism presupposes a derivative balancing of debt and liquidity; Meister concludes that the contemporary “choke points” in global economic system are the “nodes of liquidity” through which the financial system flows. (pages 143 - 173)
This chapter is available at:
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5. From the Critique of Political Economy to the Critique of Finance - Randy Martin
DOI: 10.7208/chicago/9780226392974.003.0006
[value;derivative;rate of profit;constant capital;variable capital;rate of exploitation;organic composition of capital;immanent critique]
Martin’s chapter is a close examination of chapters 13-15 of volume III of Marx’s Capital to see how derivatives might emerge and regulate some of the problems posed for accumulation by commodity production. Martin interprets Volume III as continuing the immanent critique of capitalism that started with the commodity in Volume I and argues that these chapters describe the “immanent” potential of the derivative as moving capitalism from a politics of production and commodity to a politics of circulation and mutual indebtedness. By pricing what is unpriced, especially the wealth of the future, options are a potential new source of wealth that can be tapped in the present. The “intercalation of production and circulation” that derivatives produce allows us to move beyond Marx’s production-based “politics of distribution” to a “politics of mutual indebtedness” that allow us to “enact what the social could mean and embody.” Building upon Meister’s discussion of “choke points” in capitalism, in derivative capitalism debit, credit, and currency become objects of historical transformation and not obstacles to production. He also raises the question of whether derivatives can be created not only for risk management but also to enhance volatilities that would allow us to thrive. (pages 174 - 196)
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Part III
6. Remarks on Financial Models - Emanuel Derman
DOI: 10.7208/chicago/9780226392974.003.0007
[model;volatility;arbitrage;portfolio;Black-Scholes;diffusion;replication;dilution;hedging;convexity]
This chapter presents a derivation of the Black-Scholes equation for pricing options and explains the issues surrounding the use of volatility in derivative finance. After some introductory remarks (Derman was one of the first “quants” with Fischer Black at Goldman Sachs), Derman describes the difference between a model and theory in finance and drawing upon his training as a physicist, undercuts the claim that there is a “physics of finance.” Applying the principle of riskless arbitrage, he uses Sharpe ratios to derive the Black-Scholes equation by showing how hedging, dilution, and diversification can be used to create a market-neutral portfolio in which all market-neutral stocks have a Sharpe ratio of zero; from this one can derive CAPM and Black-Scholes, where Black-Scholes is equivalent to saying that the option and stock have the same Sharpe ratio. Derman also looks at the Merton Method for deriving Black-Scholes and how to make money from trading volatility and the model's difficulties. He then describes what is wrong with Black-Scholes: implied volatilities for different strike prices and expiration dates, violating the presupposition that volatility is constant. Derman then reviews three methods used to handle the smile: local volatility, stochastic volatility models, and jump diffusion models. (pages 199 - 239)
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7. On Black-Scholes - Elie Ayache
DOI: 10.7208/chicago/9780226392974.003.0008
[Black-Scholes;Brownian motion;redundancy;stochastic volatility;recalibration;regime switching;jump diffusion;market maker;value;liquidity]
This chapter draws upon the author's experience as a trader and designer of options software. His first day of trading was Black Monday, when global stock markets crashed >20%. At that time, Black-Scholes was the standard model used to price options; his experience on Black Monday made him suspicious of the traditional understanding of probability and possibility. Using the ideas of Meillassoux, Ayache argues that “the event is unrepresentable”; yet what options pricing models presuppose is instantaneous volatility that sets market prices in the act of trading. All models must fail as explanatory devices, yet Ayache insists that their failure makes it possible for options to be traded, otherwise there would be no need for a market. For Ayache, value “doesn’t exist” because values are model-dependent; prices are given by the market; the price of a financial asset is given by its instantaneous volatility in the act of trading. The development of implied volatility, calculated from the market price of the option inserted into an “inverted” Black-Scholes equation to calculate the volatility of the underlying stock, is the closest derivative finance gets to the event of trading but it remains the model’s estimate of the future volatility of the stock. (pages 240 - 251)
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8. Mapping the Trading Desk: Derivative Value through Market Making - Robert Wosnitzer
DOI: 10.7208/chicago/9780226392974.003.0009
[animal spirits;speculative ethos;proprietary trading;bid-ask spread;flow trading;turret;performative]
Robert Wosnitzer was a trader and market-maker before he became a professor at NYU Stern’s business school. He complements Derman and Ayache’s chapters by taking an ethnographic look at market-making, specifically the speculative ethos surrounding proprietary trading. After a description of the trading floor and desks (“turrets”), Wosnitzer minutely analyzes the institutional and interpersonal aspects of several bond trades, providing a reader with a sense of both the technical dimensions and the decision-making and affectual sensibilities involved in trading. He then returns to Appadurai and LiPuma’s papers and provides a theoretical framework that analyzes trading as a “ritual” performance, capturing both its phenomenological aspects and the social structuring of the event of trading. (pages 252 - 274)
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Acknowledgments
Notes
References
Index
