How a formula for valuing American options broke the market

• 1900 Bachelier - Geometric Brownian Motion (GBM)

The logarithm of asset prices are normally distributed with mean and standard deviation being linear in time

i.e. exponential growth of asset prices

• 1963 Mandlebrot - Cotton prices do not follow GBM

Subsequently other asset prices are shown not to follow GBM

• 1973 Black, Scholes and Merton - model for valuing American options

Built on top of GBM

• 1997 Nobel Prize in Economics - Scholes and Merton

Now working at Long Term Capital Management

Black having died in the interim

• 1998 Long Term Capital Management have the US Federal Reserve intervene to save the market

They had trusted the model of Black-Scholes-Merton to always be correct