Finance for beginners

I recently discovered the Web site of John Norstad. According to his fascinating bio, John was an Iowa boy like me, who had a little too much interest in math when growing up. He now works in software development at Northwestern University, but has taken time out recently to write a number of expository papers on topics in modern finance, ranging from portfolio theory to options pricing.

Particularly nice is his note on "two-state options," a kind of toy-model world that helps develop intuition. One thing that always used to bother me was how the price of an option could really be independent of the assumed "drift term" in the Black-Scholes model (you can find this debated by real practitioners here). An explicit model in which one can replicate the derivative using cash and shares of the underlying security makes this more transparent. The deep insight is that all expectations about future returns on the underlying are contained in the instantaneous price. This also clarifies the observation that derivatives can be priced in a risk-neutral way, as I mentioned in my post on path integrals.

I haven't looked at all of his papers, but they seem just right for someone with a background in math or physics who wants a clear, concise, but theoretically sophisticated introduction to this subject. I usually tell people to read John Hull's introductory textbook, but I think a stop at Norstad's site might be very worthwhile.