TABLE OF CONTENTS The development of options pricing theory is intimately related to notions associated with stochastic processes. The first important work on options pricing, Louis Bachelier's (1900) doctoral dissertation, also represents a significant early contribution to the theory of Brownian motion. Bachelier's work predates and anticipates Einstein's work on Brownian motion 5 years later. Unfortunately, Bachelier's thesis passed largely unnoticed and was only "rediscovered" by Paul Samuelson around 1954, following the "rediscovery" by Leonard Savage of a 1914 Bachelier publication on speculation and investment (Bernstein, 1992). Bachelier entered the mainstream of financial economics in the mid-1960s when his thesis was included in Cootner's (1964) seminal book of readings on the random behavior of stock prices. [2]
The theory of stochastic processes, proper, has a much longer history. One possible starting point would be the work of Abraham de Moivre in the 1730s when he derived the normal distribution as the limit of the skew binomial. A more traditional starting point dates back to 1827 when the English botanist R. Brown observed that small particles, suspended in a liquid, exhibited "ceaseless irregular motions." This observation was subsequently applied to the behavior of various other physical objects, such as smoke particles suspended in the air. [3] The important modern contributions in stochastic processes can be traced to N. Wiener in 1918. [4] His role is recognized in the use of the term Wiener process to signify the fundamental building block of...
