Kellogg World Alumni Magazine, Spring 2004Kellogg School of Management
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  Derivatives Markets

Kellogg School professor leading the way in derivatives research

By Deborah Leigh Wood

Derivatives Markets, written by Kellogg School Finance Professor Robert McDonald, has been adopted by business schools worldwide, and for good reason: It's the only text out there that provides finance students with an economic perspective of derivatives.

In addition to being used at the Kellogg School, Derivatives Markets (Addison Wesley, 2002) is required reading in courses at the University of Chicago Graduate School of Business, the Harvard Business School, the Wharton School at the University of Pennsylvania, the London Business School, Princeton University, the University of Illinois at Urbana-Champaign, Boston College, Boston University and universities in Australia, Canada, New Zealand and Norway.

McDonald, the Erwin P. Nemmers Distinguished Professor of Finance at the Kellogg School, decided to write the book after becoming dissatisfied with existing texts on derivatives --- financial instruments whose value is based on other securities such as options, futures and swaps.

Specifically aimed at the MBA student, Derivatives Markets "has more examples and more illustrations of use," McDonald says. "It explains what's behind the math." Derivatives courses are an essential aspect of modern finance, he says, particularly for students interested in areas where derivatives are important, such as investment banking, commercial banking, management consulting and investment consulting.

Robert A. Korajczyk, Kellogg School senior associate dean for curriculum and teaching, calls McDonald "a pioneer in developing option pricing theory" in situations different from those applicable to exchange-traded options. This area of research has come to be known as "Real Options Theory."

"The problems that Bob's research addresses require a greater grounding in economic analysis than do standard problems," says Korajczyk.

"This grounding in economics carries over to Derivative Markets in that the book does a wonderful job of teaching the reader the economic intuition of derivatives markets in addition to the mathematics of derivative pricing," Korajczyk says. "This allows the reader to answer the 'why' questions in addition to the 'how' questions."

McDonald says he's "gratified at all the positive feedback" he has received from peers at other business schools who also noticed the "gap" in derivatives texts. He attributes this gap in part to the relative newness of the derivatives market. In Chicago, options trading began in 1973 with the introduction of the Chicago Board of Options. Prior to that, options transactions were handled over the phone by stockbrokers.

Many academic institutions started offering courses on the derivatives market in the 1980s, so textbooks are "still evolving," McDonald says, and so is the derivatives market itself. In addition to stock, interest rate, commodity and exchange rate risk, it is now also possible to trade risks related to weather and unemployment statistics.

McDonald says he finds the field of derivatives fascinating and fun because it "blends economic theory and practice and offers an analytical framework with widespread applicability in finance."

©2002 Kellogg School of Management, Northwestern University