merton engineering document

May 15th, 2015
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Finance and the Role of Financial Engineering in the 21st CenturyRobert C. MertonDecember 12-13, 20011IntroductionI am privileged to take part in this consequential Symposium on nancial engineering,which celebrates the creation of the Research Center of Financial Engineering at the Instituteof Economic Research and the development of the nancial engineering program at thedepartment of Economics at Kyoto University. I thank Kyoto University for inviting me,and thank the Nikkei for its support. That the Center is established at Kyoto University hasspecial signicance both for me and for the nancial engineering profession at large. Thegreat Japanese mathematician Kiyoshi Ito has been a faculty member of Kyoto University formore than 40 years: 20 years as a senior professor and the balance to this day in an emeritusrole. Thirty years ago, I introduced his stochastic calculus into economics as an arcane butessential mathematical tool to develop my continuous-time theory of nance. Indeed, it wasItos calculus that I used to demonstrate the existence of a dynamic portfolio strategy thatreplicates the payos to an option, my core contribution to the Black-Scholes option-pricingmodel. Today, every student of nance knows his name. Knowing Itos calculus is requiredtraining for all nancial engineers.This afternoon I will address prospectively the practice of nance and the science ofnancial engineering as we move into the 21st

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