Black, F., & Scholes, M. (1973).
Published in 1973 by Fischer Black and Myron Scholes, this paper fundamentally changed the way options are valued. It wasn’t just a theoretical breakthrough, it was a revolution that reshaped modern finance and remains at the core of today’s derivatives markets.
The core idea is based on a fundamental concept in finance: the absence of arbitrage. Black and Scholes demonstrate that by dynamically combining an option with its underlying asset, one can construct a risk-free portfolio, leading to a mathematical formula for determining an option’s theoretical value. Their approach relies on Brownian motion and stochastic calculus, with a differential equation that describes the option’s price evolution based on time and the underlying asset’s volatility. What’s fascinating is that their reasoning eliminates any subjective risk estimation, relying solely on market-observable parameters.
Before Black and Scholes, option valuation was more intuition-based, relying on empirical rules without a solid theoretical framework. Their model not only allowed traders to price options rigorously but also paved the way for an explosion in derivatives markets and the development of an entire industry around risk management and financial engineering. Their work is so foundational that option prices are still calculated today using variations of their formula.
In terms of difficulty, I’d give it a solid 9/10. It’s a dense paper, packed with advanced mathematical concepts, particularly in probability and stochastic processes.
Miller, M.H., & Modigliani, F. (1961).
This paper is an absolute classic in finance, the kind that never ages and laid the foundations for modern research. At first glance, its conclusion might seem provocative: dividend policy has no impact on a firm's value in a perfect market. But once you dive in, you realize it’s a demonstration of relentless logic, systematically dismantling the traditional intuition that paying dividends is inherently beneficial for shareholders.
The central argument is based on a simple yet powerful idea: investors don’t need the company to pay them dividends to access cash. If they want liquidity, they can sell part of their shares; if they want to reinvest, they can buy more. In a perfect market, without taxes, transaction costs, and with equal access to information, the way profits are distributed has no impact on a firm’s value. In other words, what truly matters is the profitability of the investments made with those profits, not how they are distributed.
What makes this paper historic is that it fundamentally changed the way we think about corporate finance. Before Miller and Modigliani, many believed that dividends were essential to attract investors and signal a company's strength. Their model forced researchers and practitioners to rethink this idea: rather than focusing on dividends, the real priority should be capital structure and investment profitability. This reasoning sparked decades of debate on the true impact of dividends, leading to studies that introduced more realistic factors such as taxation, market imperfections, and information asymmetry.
I’d give it a solid 8/10. This isn’t a paper you skim through. It contains a fair amount of mathematical formalism, and the proofs require real rigor to fully grasp. But once you understand the underlying logic, it becomes crystal clear and completely reshapes the way you see corporate finance.
Riedl, A., & Smeets, P. (2017).
The authors take an approach that goes far beyond traditional explanations of sustainable finance. Instead of simply assuming that these investors seek a financial return adjusted for ESG criteria, they explore whether these decisions are purely rational or influenced by psychological and social factors.
What makes this study particularly interesting is the diversity of methods used. Rather than relying solely on traditional empirical analysis, the authors combine portfolio data, surveys on investor preferences, and even incentivized economic experiments. This approach allows them to go beyond stated intentions and observe how individuals actually behave when their financial choices have real consequences.
The main finding of their research is clear: SRI investors are not solely focused on maximizing profit. Many are willing to accept higher fees and potentially lower returns, not because they expect these investments to outperform in the long run, but because they value other factors, such as the environmental or social impact of their investments.
One of the most fascinating aspects of this study is the distinction it makes between two types of SRI investors:
- The "committed" investors, who invest in these funds out of personal conviction, regardless of expected performance. For them, aligning their portfolio with their values is the top priority.
- The "social strategists", who view responsible investing as a way to enhance their image or conform to social norms. Their commitment is often more opportunistic and influenced by external perception.
What makes this paper so impactful is that it challenges the assumption of total rationality in finance. It shows that socially responsible investing is as much about psychology and perception as it is about risk-adjusted returns. This research paves the way for a new approach to analyzing sustainable finance, one that accounts for the non-financial motivations influencing investor decisions.
In terms of difficulty, I’d give it a 7/10. The study is well-structured and accessible, but it requires a solid understanding of behavioral finance and experimental methods. What struck me the most was its ability to turn commonly expressed intuitions into measurable and rigorous data, providing deeper insight into why investors actually choose SRI funds.
Schrimpf, A., Sarno, L., Menkhoff, L., & Schmeling, M. (2012).
This paper tackles one of the major paradoxes in forex: how a strategy as simple as the carry trade can generate high returns while seemingly violating the efficient market hypothesis.
The carry trade is an extremely popular currency trading strategy: investors borrow in a low-interest-rate currency (e.g., the yen) to invest in a higher-yielding currency (e.g., the Australian dollar). On paper, it looks like free money, but this strategy comes with a major risk: periods of high volatility, where investors flee risk, and these positions can collapse.
The key contribution of this paper is its demonstration that the carry trade risk premium is directly linked to overall forex market volatility. When volatility is low, traders take aggressive positions, and carry trade returns are high. But when volatility spikes, often during financial crises, these strategies can suffer massive losses as capital flows out of high-yielding currencies into safe havens like the yen or Swiss franc.
What makes this paper historic is that it explains why the carry trade works over the long term, despite its risks. It’s not just a simple interest rate arbitrage, it’s a compensation for the risk taken during crises. This perspective has profoundly influenced how institutional investors and hedge funds manage their forex exposures, integrating volatility measures as a key variable in adjusting their positions.
I'd give it a solid 8/10 in terms of difficulty. The paper is dense, with advanced econometric models and in-depth empirical analysis covering decades of forex data. It requires a strong understanding of currency markets and risk premia, but once its core ideas are grasped, it provides a powerful analytical framework for understanding one of the most widely used strategies in international finance.
Tufano, P. (1996).
The study focuses on North American gold mining companies, an ideal setting for analyzing risk management, as these firms are directly exposed to gold price fluctuations. Tufano examines the strategies used to hedge this risk, including futures contracts, swaps, options, and gold-linked debt. What makes his approach particularly interesting is that he doesn’t just investigate whether firms hedge, he seeks to understand who within the company makes these decisions and why.
One of the paper’s most striking findings is that risk management is largely influenced by executive incentives.
- Executives with significant equity holdings in their firms are more likely to hedge risks to protect their own wealth.
- In contrast, those holding stock options are less inclined to hedge, as they benefit more from high volatility, which can significantly boost the value of their options.
This paper is crucial because it challenges the notion that risk management is purely about rational optimization. It highlights behavioral influences and conflicts of interest in financial decision-making, paving the way for further research on how managerial incentives shape risk management strategies.
I’d rate it a 7/10 in difficulty. While it doesn’t rely on complex mathematics, it requires a strong understanding of hedging mechanisms and how executive compensation structures impact financial decisions. What makes it fascinating is that it offers a much more realistic view of corporate finance, far from the idealized models where decisions are always rational and optimal.