Robert Merton and the effect of time on portfolio choice

FINANCE THEORISTS are, as everybody knows, unworldly people who can scarcely tie their shoelaces, still less change a car tyre. Robert Merton confounds this stereotype. As he talks amiably at the London office of Dimensional Fund Advisors (he is the firm’s “resident scientist”), you sense that here is a man who could fix a flat in no time. He would probably deliver a cheerful lecture on the importance of the correct tyre pressure while he was tightening the wheel nuts.

Mr Merton has always had a bent for engineering, whether financial or mechanical. He bought his first stock aged ten and completed a risk-arbitrage trade (on a takeover by Singer, a maker of sewing-machines) aged 11. He rebuilt his first car aged 15. In 1997 he won the Nobel prize for economics aged 53—a career high. A year later, a career low: LTCM, the hedge fund he co-founded, imploded. These markers of the passing years matter. For Mr Merton’s specialism is the mathematics of time applied to finance.

His first paper on the subject was published almost exactly 50 years ago. Its title—“Lifetime Portfolio Selection under Uncertainty: The Continuous-Time Case”—is forbidding. The ten pages of equations that follow are daunting. But for Mr Merton, the equations are tools, no different from a car jack. They allowed him and subsequent researchers to clarify...

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