In the wake of that paper appearing, Merton sent Taleb a detailed and equation-filled eight-page note, dated December 2005, taking issue with the paper. "His argument was that my argument was not compatible with portfolio theory," says Taleb, who says that Merton assumed, in his paper, the very constructs — things like beta — which Taleb criticized; which are as meaningful for him as astrology; and which have no place in the world of financial economics.
Merton never published that note. Rumor has it, however, that he posed Taleb’s paper as a problem set for his students. And a few months later, a paper appeared under the names of Doriana Ruffino and Jonathan Treussard, defending Merton, and saying, in its abstract, that Taleb’s paper "is inconsistent with modern equilibrium capital asset pricing theory" — the same portfolio-theory concepts which Taleb rejects and which Merton had used in his own note.
Treussard was working for Merton at the time, at Integrated Finance Limited (IFL) in New York, and Taleb takes Treussard’s paper to be no less than Merton writing under someone else’s name: "it was written by Merton and published by one of his employees," he says.
Taleb responded to Ruffino and Treussard in a footnote in a paper co-written with Espen Haug and entitled "Why We Have Never Used the Black-Scholes-Merton Option Pricing Formula", which rapidly became one of the most downloaded papers of the year at ssrn.com. In the footnote, Taleb and Haug accused Treussard (and, by implication, Merton) of being "scientists lecturing birds on
how to fly, and taking credit for their subsequent performance
– except that here it would be lecturing them the wrong way."
More recently, on Tuesday, the Economist’s economics blog reignited the debate, saying unambiguously that Treussard had disproved Taleb’s theories. The author of that blog entry didn’t write it on the direct instructions of Merton, but she, too, worked for Merton at IFL, and considers him a mentor.
Taleb, a former options trader, smells weakness. "It is quite distressing for Merton that he can’t find anybody to defend him in financial academia, other than his minions," he says. "The man invented a fantasy world in which his argument is airtight, and then he said my argument doesn’t hold. But in his fantasy world, LTCM [the hedge fund which Merton co-founded and which blew up in 1998] couldn’t happen."
And so, on a quiet Friday, I’m letting myself be pulled into a clash of egos between Taleb and Merton. For the record, although I’m sympathetic to Taleb’s side of the debate, I have no reason to believe that Merton is waging some kind of deliberate proxy campaign against him.
The interesting thing for me about this particular academic feud, however, is that that for all its viciousness, the stakes really aren’t low at all. Taleb is working towards nothing less than the outright dismantling of Black-Scholes, portfolio theory, and the enormous financial edifices which have been built upon them; if he’s successful, essentially all the quants on Wall Street would be out of a job. Which I think is probably reason enough for many people to defend Merton right there: the man himself doesn’t need to direct anything at all.