Risk Latte - September 11, Berkeley and Two Very Bright Guys

September 11, Berkeley and Two Very Bright Guys

Rahul Bhattacharya
Mar 13,2006

We all have our 9/11s, the day our tears dried up and the heart felt the heaviest ever.

We all remember September 11, 2001 and for generations to come history books will mark this date as the turning point in human history, when relationships between countries, peoples and different cultures were altered for ever. That was our September 11, sad, sorrowful, and traumatic; and of course, an inflexion point.

Speaking of September 11, there is one September 11 that is quite unique in the world of finance. Portfolio Insurance, which the fund managers swear by today and very few understand, was born on September 11, 1976. Hayne Leland, one of the brightest minds to come out of Berkeley-University of California at Berkeley-conceived of this idea on September 11 of 1976. Or so Mark Rubinstein in his article The Evolution of Portfolio Insurance (published in the book Dynamic Hedging: A Guide to Portfolio Insurance, John Wiley 1988). Mark Rubinstein is another luminary to come out of Berkeley and someone whose contributions to the world of finance, from Portfolio Theory to Option Pricing has changed our world view. Mark Rubinstein and Hayne Leland are credited with the invention or rather innovation of Portfolio Insurance (because nothing is an invention in finance). Apparently, on the night of September 11, two months before Milton Friedman's landmark Nobel Memorial Lecture at the University of Chicago, and as Americans were coming to terms with the new Copyright Act and a group of intellectuals in Poland were forming the Committee for Defense of Workers Hayne Leland was dreaming of a financial product that will fill the void that was created by the American equity markets in the decade of seventies.

1976 - It was the best of times and it was also the worst of times. Rocky was becoming the darling of millions of American youth and unemployment was hitting 7.7% in America; Pol Pot was ushering in his infamous rule of torture and dictatorship in Cambodia and the US Supreme Court was making the death penalty a constitutionally acceptable form of punishment; Fisher Black was formulating the option pricing formula for futures contracts and Israeli commandoes were raiding Entebbe's airport in Uganda to free 103 Israeli hostages. And as in that year Alex Haley's Roots was recounting the entire saga of African-American experience across bookstores in America and the bear market rally was coming to a close the lifestyles of the academics in California was in jeopardy and Hayne Leland at Berkeley was pondering on a new product -a product that would alter the way money was managed for ever.

1976 was our generation's 9/11 and in more ways than one. It would introduce us to a world that was never there before. And as old merged with the new there stood UC at Berkeley witnessing the tide of time and producing one genius after the other. And in 1976 the theory of Portfolio Insurance was born, thanks to two of Berkeley 's famous researchers, Hayne Leland and Mark Rubinstein. The night of September 11, 1976 was quite special as was of course the morning of September 12, 1976.

On September 12, 1976 Mark Rubinstein and Hayne Leland verbally agreed to form Leland-Rubinstein Associates to "develop the technique and appropriate software to provide portfolio insurance" ( Dynamic Hedging: A Guide to Portfolio Insurance, John Wiley & Sons 1988 ). And thus began the long road to developing a whole new branch of money management and stock investment that would meet its nemesis in the form of the stock market crash of 1987 but would eventually redeem itself to shape the way fund managers and institutional investors manage funds today.

And in their long and tortuous path to popularize their theory of portfolio insurance and educate the high pundits of finance about its virtues another Berkeley Professor Barr Rosenberg played a small role as well. But that story is for another day.

© Rahul Bhattacharya
This column is written by Rahul Bhattacharya and reflects his own views about life and business. It does not necessarily reflect the views and opinions of other members of Risk Latte Company Limited, Hong Kong (“the Company”) and the Company accepts no responsibility for any factual errors contained in the column and strongly advises readers not to pay much attention to it.

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