Robert C. Merton PhD ’70

INTERVIEWER: Today is April 27, 2011. I'm Barbara Moran, and today we are speaking with Robert Merton at the MIT studio as part of the MIT 150 Infinite History project. Dr. Merton, the distinguished professor of finance at the Sloan School of Management, has spent his career applying high-powered mathematics to the real world. His research focuses on finance theory, including life cycle finance, pricing of options, loan guarantees, and other complex derivative securities. He has co-written or co-edited 10 books, is the author of more than 90 articles, and is a member of the National Academy of Sciences.

Dr. Merton graduated from Columbia University with a degree in engineering mathematics in 1966, earned a Master's degree in applied mathematics from the California Institute of Technology, and a PhD in economics from MIT in 1970. He received the Nobel Prize in Economics in 1997 for a new method to determine the value of derivatives.

Welcome, Professor Merton. Thank you for joining us today.

So I want to start-- when I was reviewing your CV, the first thing that jumped out at me was the fact that you got your PhD here, you had 20 years at MIT, 20 years at Harvard, and then you came back. We got you back. So I was wondering if you could tell me why you came back. Glad you did. Thank you for coming back.

MERTON: It's my pleasure. Well, I guess I could just quip, you know, every 20 years or so, you have to do something radical and move from one end of Cambridge to the other. Well, I've always-- the Institute is a very special place for me. As you say, I got my degree here. This is where I did my best work. I love the students here. I was here, as you mentioned, 20 years.

And then around that time, I took a year, my first year off, to write a book that I'd been wanting to write. And it was a culmination, really, of the work I had done in for the past couple of decades. It was kind of written to put it all together.

And I had a wonderful time writing it. I was so much involved in the Institute that I had to go somewhere. And the Harvard Business School said, well, why don't you come up? We'll give you a nice place. And it'll be quiet. You have nothing you have to do. And this was great, because I could write my book and I wouldn't have to leave. So that's how I got to the other end of town to do it.

And then at that time, I had decided I was going to go another direction of research of large change, in the sense of still within finance, but focusing more on understanding the dynamics of institutional changes and so forth rather than prices and instruments. They were connected, but very different style.

And after I spent this year, I was invited to stay at Harvard. It was very difficult for me, because MIT is a great place, and truth be known, if I had to come back, I would have been very happy, too. But I got to take advantage of the fact that I wasn't really leaving MIT. Because I was actually live only a quarter of a mile from the Institute, and all my friends, colleagues were still here, and I still interacted with them. So I kind of got the free ride in this.

And I think it was a combination maybe of just a change, but also the idea that I was going to be involved more in understanding how institutions work and so forth. And it seemed to me at the time that perhaps the resources available at the Harvard Business School would be more conducive to that.

INTERVIEWER: Hmm. Are there are some differences? What are some differences between the two schools?

MERTON: They're very different, just as East and West Cambridge are very different, happily so. The Institute had always struck me as a place that was, on the surface, a little more relaxed dress and all. Of course, we know, in reality, it was very rigorous, demanding, and so forth. I think you see it in the art and design. It's more modern, it's more eclectic. Certainly engaged in technology, certainly more than Harvard as a whole university.

And while the business school, as a professional school, was focused on practice as well as research, it just is a very different character. The nature of the people, the students. I didn't say better or worse. Different.

INTERVIEWER: Not saying better or worse. Just saying different.

MERTON: No, but different. Also there, even with the students, I continued to have many MIT students whom I served on their thesis committees, and they came over and took classes with me. So in some sense, I never really left the Institute, from a personal point of view.

INTERVIEWER: Yes. So what made you decide to come back here formally?

MERTON: It was somewhat a serendipitous event. I was quite happy at Harvard. And as a university professor, you have a lot of freedom. You can do pretty much what you want. And I was treated very well there.

I happened to have lunch with Andrew Lo, whom I've known for a long time, who was the unit head for the finance group here. And he was telling me about some of the new programs that they were designing, what they were trying to do here at the Institute. And I thought it fascinating. And as he talked to me about it, at some point he said, well, would this ever interest you? And I didn't think about it. I said, hmm. It makes sense. I mean, you know, you don't normally move.

And this was also part of the serendipity-- not a good part of it. But we had this terrible financial crisis that occurred. This occurred really 2007-2009, which we're still feeling the effects of.

And my belief coming out of that was that in my field of finance, where much of this was centered, the financial system, one of the things that we really do need more of is better-trained people. From the most senior people, meaning senior executives, board members, regulatory overseers. They just have to understand much better the technology and how these things work in the modern financial system. And they also need staffs of very well-trained people, in my view. And this is a global issue. It's not for the US and the UK. It applies around the world.

And at this time, it just seemed to me what one could do, is sort of, it's fun to do, exciting to do, and also feel that it's the right thing to be doing to contribute. And it would be to get involved in a program that was designed to turn out a very large number of highly-trained people in this area to meet that need. And the Institute is the perfect place to do it.

Plus, the reality was that from the president on down here, there was a commitment to this new program, which was called the M.Fin program for students. Master's in finance program. This is in addition to our Master's program and our PhD program. But this was really designed to turn out very highly-trained people in finance who would start at the bottom, whether in private sector or in the public sector, but would bring this very, very rich set of tools and knowledge, and then gain experience, and be available first to implement what needs to be done in a well-done fashion, and eventually grow into positions of influence and oversight. And we want to do this for the whole world.

INTERVIEWER: It's very interesting, because a lot of what you were just talking about fits in with these other big picture issues of MIT's role in the world, and the role of engineering in the world, and the role of engineering in finance. And I saw a quote from you somewhere that you said you're an engineer at heart, or an engineer by nature.

And can you just talk a little bit-- it's a sort of an interesting-- I mean, a lot of people, I believe, when they think of engineers, they think of people who build, whatever, bridges and cars and that sort of thing, not people who try to engineer finances. Can you just talk about MIT's role there, and how you fit into that and your way of thinking fit into that?

MERTON: Sure. As you quoted me, I was describing my personal characteristics. For example, I would make a very poor candidate to be a doctor in an emergency room, because all the patients would probably die. Because I would want to do everything precisely, and you can't do that when they're in trauma.

That said, if you go to an emergency room, let the ER doctor treat your trauma. Don't let the ER doctor set your broken leg. If you want to last for 30 or 40 years and work, that's the wrong temperament.

So part of that was to describe by temperament. So therefore, for example, with respect to the crisis, although I've obviously been involved in advice and so forth in that area, actually it's not something that I feel is my relative expertise. That's dealing with crisis, immediate things and fixing stuff. Which is very important. I like to build. So in fact, that's what-- so that was part of it.

Now clearly, that fits very well within the character of the Institute. If you go to the main building, from its very beginnings, of course there was a focus on deep research, generation of knowledge, both In sciences and the surrounds. But always with a focus towards application. That these things could be brought to bear to make the world a better place, to solve real problems that we face. And that's the application here.

And one of my original work I did in helping to contribute to create this, what was really a new field, financial engineering and the whole new way of looking at, this was the perfect place to be for it. I mean, the technology that, now I'm talking about computer technology and so forth, but just the whole mindset.

And is it really is parallel, in fact, much of the mathematics sometimes can look very similar. The same equations that appeared in heat transfer, or mechanical engineering, or the same mathematics used for rocket trajectories, how they go, are also the same kinds of mathematics that we use to design and build and understand the characteristics of the financial system.

INTERVIEWER: It almost seems like it was the only place where it could happen in a way, do you know? I mean, I'm sure it could happen other-- but I mean, it's like a perfect confluence of factors here.

MERTON: It was a perfect confluence. And in the early part of my career, you know, when you're young, you don't know any better. So I grew up here at the Institute, and everything was fantastic. We had a fantastic time -- a student. And then later, joining the faculty, there couldn't be anyplace better. Everything was wonderful. It's only when you grow up and realize what the rest of the world is like do you appreciate how special it really is.

INTERVIEWER: Yes. So I wanted to go back a little bit and talk about your life before you got to MIT. So you had a quite an interesting childhood, I think, as far as your father being this acclaimed sociologist who invented pretty much every sociological term we've ever heard. That's fascinating. And so I'm just wondering. Could you just describe your household growing up? What was it like?

MERTON: Well, my household-- I actually grew up in a town just north of Manhattan called Hastings on the Hudson. It's a relatively small town, and remarkably, today it remains so. It was a solid middle class town. It had some factories. A good part of the graduates of the high school went to work in the factories.

But it also had an interesting sort of bunch of characters that lived there, including the Cubist sculptor, Jacques Lipchitz. And also later on, much later on-- now I'm moving forward to today-- it turned out that I think there's, in one way or another, seven Nobel laureates in the little town.

INTERVIEWER: Huh! No, really?

MERTON: Yes. Over many, many years if you look at the number. But it wasn't one of these university towns or lab towns where you might guess. It's just truly a kind of ordinary town, but with some interesting people. It was close to Manhattan. The school was K - 12 in one location, and it was truly a public school. I got a fabulous education there, thanks to Sputnik and MIT. So there was early connection.

But I think beyond that, I have two sisters. One time I had 25 cats.

INTERVIEWER: I heard about that. Those were grandma's cats? Or were they your cats?

MERTON: Well, I would take credit for some of them.

INTERVIEWER: How does that happen?

MERTON: Well, you have one. And she has five. And then some of them grow up, and pretty soon, you have a lot of them. Anyway, so I guess that's sort of an odd thing.

But in terms of my surroundings, my father was, as you indicated, a really eminent scholar. And he taught me many, many things. I was the black sheep in the sense that my two sisters were the smart ones. And if you had a who was most likely to succeed contest, I would have lost. I did lose.

But other than that, that was fine. He set more by example. Never was one of these people like some of my classmates, whose parents really pushed them, particularly the academics, to go on and on and on. I was never formally pushed about it, but he just did it by example. I just absorbed what standards were, and how you do things by observation, rather than being sat down and told.

And my mother was a big influence on me. At one point, she gave me some advice. I mean, she gave me much advice. But one piece of advice she gave me which has influenced my views of how I do things was she said, first do it their way, and do as good as anybody can do it. Then you've proved you can do it their way. Then you're free to do any way you want.

And she illustrated that to me in the case of art. When I was little, I saw these abstract sculptures that Lipchitz had done. He was a neighbor. And I'd look at them and I'd say, you know, what are these things? You know the traditional sayings.

So rather than tell me, you need to develop a taste to understand this and all, she took me to see many of the busts that he did that were perfect. They were in bronze. But the facial features and everything were like they were alive.

And her point was to say, look. He can do art that is so realistic that the bronze becomes alive, in terms of capturing the person. Having done that, he sort of earns the right to-- that he's doing these abstract things not because that's all he can do, but because that's what he chooses to do.

And while this may seem a very sort of folksy type of thing, it had a very big influence on way I've done things. I always have said, look. I can do it the way it's normally done or traditionally done, and then felt that that gave me the license to then do it my way.

INTERVIEWER: Very interesting. I also understand that baseball and cars had a big influence in your early life. What do you think is the common-- well, I guess baseball, cards, poker. I don't know when poker came in. But what was the common thread between--

MERTON: And the stock market? Well, I suppose we could try to look for something. That'd be natural. I guess I really don't know what the connections were. What they all had in common was passion. And there were certain things I developed a passion for, and I came to appreciate how great that was when you could get it.

And also to recognize that if you have a passion for something, you can really do almost anything. And if you don't, if you're dealing at the highest level of performance in any field, you're probably not going to be able to compete. Because there's always someone faster, smarter, better-looking, richer than you are. But if you have passion about it, just because you love it, you can do more of it, and you can do it well. And at that level, that's the edge.

And so it was just enjoyable, but those were my passions. It was baseball--

INTERVIEWER: So playing or watching--

MERTON: I played--

INTERVIEWER: --collecting stathead?

MERTON: Well, I became a stathead on everything I did, but I don't think that's special. I can still tell you the cubic inches and the different models of every engine and car built in the 1950s or '60s, early '60s. And you're certainly familiar with people with baseball statistics.

But I was preparing myself for coming to Boston. I didn't know it. Because at the time in baseball, there were three teams in New York. The New York Yankees, the New York Giants, and the Brooklyn Dodgers. Which, for a baseball fan, that's just nirvana.

And of course, I was a Brooklyn Dodgers fan. The Yankees were the big success, rich ones. And you didn't do it. And the Giants didn't know where they were. But Brooklyn. And there was this Ebbets Field out in Brooklyn. Just like Fenway Park. Totally kinky, totally crazy. Small. Great fans. And by the way, the Dodgers never won a World Series until 1955. I actually was there to see them win the pennant.

But sort of the history of the Red Sox from 1918 on, I knew that well when I came here. I felt very comfortable. And Fenway Park felt that way. So maybe there's another connection that developed.

And then I wanted to switch to cars--

INTERVIEWER: So baseball was sort of like early, age 10 type thing, and then you switched to cars?

MERTON: Yeah, age 10 to 12. Well, from seven, eight to 12. And I played sports in school. I played football. I ran track. Things like that. But I confess, I didn't have a passion for them. I played them. I don't know why I did.

But then it became cars. And because I was too young, I got to know older people who did have cars, and I helped build them. I learned how to build them. And eventually I built my own. You know, hot rods and things that. Cheap-- no money, lots of labor.

INTERVIEWER: Did you buy a junker and fix it up, or did you--?

MERTON: Yeah. The first car I bought for myself, I was, I guess, 15, was a Cadillac convertible. Fabulous thing with big fins, leather, the whole nine yards. In terrible condition. I bought it for $75.

INTERVIEWER: Nice.

MERTON: And I rebuilt everything, from the engine, the body, everything. Floorboards. The whole thing. And then sold it, because I couldn't drive it legally. And eventually I built cars. As I said, I used to build them and then race them on tracks.

INTERVIEWER: Yeah. So explain this. So I read about this drag car-- so I don't actually know what a dragster is. Is that like in Grease?

MERTON: That's where you go a straight line around the center. It's all about getting on a line and going as fast as you can for 1325 feet. And as fast, as quickly as you can.

INTERVIEWER: Huh. That's an interesting little niche to get into.

MERTON: Well, it fits into-- I didn't have any money, so it was one of these things where labor and going to junk yards and doing a lot of the work was all the fun of it. And then as a teenage, testosterone-type kid, I got a great deal of pleasure out of it when some other male, who had his dad's Corvette, was taking a lady out somewhere, and I had my old '48 Chevy, but the darn thing would run about three times as fast as that Corvette. And I always had in my dream that she would say to him, what's wrong with your Corvette?

INTERVIEWER: Right. See you later!

MERTON: You see the level of this sort of thing. But it was competitive. And I actually thought that I was going to be an auto engineer, and actually all through engineering school, though engineering mathematics was my field, and I did everything because I thought -- but I actually worked for Ford for a couple of summers as an engineer.

INTERVIEWER: Yeah. Why didn't it stick, do you think?

MERTON: I don't know. I mean, it was a lot of fun. I did it. But I liked the mathematics, and so then I decided to get a PhD in applied mathematics.

INTERVIEWER: Well, I wanted to back up a little bit. Because you have this somewhat roundabout path into getting a PhD in economics. Can you just talk about how you got there?

MERTON: Well, going back to one of the things I had a passion for, along with various stages-- baseball, cars. I learned to play poker. I also learned magic. My father was a very good mathematician.

INTERVIEWER: Magician?

MERTON: Magician, yes, thank you. He was not a mathematician. But that didn't stick. But the poker did.

INTERVIEWER: Do you still have a couple tricks you can pull out once in a while?

MERTON: No, no. The rule is, you never do a trick until you perfect it, because then you'd expose it. And I can't say it was because I had small hands. These are real tricks. They're not props. You have to practice them. And I didn't have the temperament or the passion to do it. So that didn't stick.

But in any case, I bought my first share of stock when I was 10.

INTERVIEWER: Right. Now, how do you do that when you're 10?

MERTON: Oh, I got my father to open an account and told him. I just did it for my aunt and for him. They didn't have a lot of money. But I would do all this analysis for them of the companies, and--

INTERVIEWER: How does a 10-- I mean, from the newspapers? Is that what you did?

MERTON: No, I got things like S&P guides, and I--

INTERVIEWER: You're making that up. What 10 year old-- you had a lot of time! Building cars, baseball--

MERTON: I didn't build cars when I was 10. I was a little older. No, well. If you really want to-- when I was younger than that, I used to like to pretend design things. So I used to have all these companies that I made up. One was called the RCM Savings of Dollars and Cents Company, which was, I would collect from the people in the family and around money. You know, like a banker. And then take it down to the-- the S&L had an account. Put in the account and earn interest. And then I would pay them interest-- less-- on it.

So I guess there was some characteristic of that beforehand. I used to take care of my mother's checkbook and make sure it balanced and that sort of thing. I don't know. Who knows what these are.

But in any case, I was very interested in stocks. GM was the first stock I ever bought.

INTERVIEWER: All right. Now, were your sisters during this same stuff, too, or were they just--

MERTON: No. There's no connection.

INTERVIEWER: Or were they just like, what's Bobby up to?

MERTON: Yes, exactly. So I got involved with stocks. And then later on, when I was older, I would go to what they call boardrooms, which were the brokerage houses. And I'd go first with my father, and then later-- and there were these places where people who would go there all day long to trade. You know, civilians, not trade like Wall Street, but civilians. And they would sit there and watch the tape, because that's all there was. There was no electronic--

INTERVIEWER: Oh, it was an actual tape-tape.

MERTON: Well, it wasn't paper tape. It was electronic tape. But that's where you got your information. And they would teach me how to read the tape. I knew all the symbols of all the stocks on the New York and AMEX, American Stock Exchange. And they would show me this, and how this-- see this little tick? Well, that's the specialist stealing from somebody. And then they taught me about a thing, and one fellow taught me about convertible bonds.

So I used to go there. I was kind of their mascot. I traded. I didn't have much money, but I would trade, too. And so I was engaged in all of this.

But they never thought of it as a day job. It was kind of an after hours sort of thing one did. And so in that sense, I was always involved with financial-type things.

INTERVIEWER: If you had to sort of examine, what interested you about it? Was it some sort of a game? Or was it thinking about making money? Or was it just the analytical aspect of it, or what do you think about it?

MERTON: I think it was partly the challenge of understanding it. It was partly non-periodic positive reinforcement. Every once in a while, something did actually go up and you made money, and you know, psychologically, that's very addictive. You know, sort of understanding how it worked. I built some models. I didn't know what I was doing, but I thought I did.

And as a consequence, that did have an effect that carried all the way through to eventually being in the field. But I just didn't know it at the time. It was really-- I don't want to say a hobby. It never occurred to me that would be what I would do during the day, if you know what I mean.

INTERVIEWER: Right, right. Interesting. I mean, it does sound like your parents were quite supportive of all this. That they let you build a car, you know?

MERTON: They let me build a car, make a lot of mess in the garage.

INTERVIEWER: Yeah. They took you to the, what did you call it, the board room, the trading room?

MERTON: My father would take me up to the board rooms, right.

INTERVIEWER: Yeah. So they must have seen, you know. something.

MERTON: I guess so. My father had many interests, but he was a really serious academic. One can say that about a parent. You can't say it about a child. I had nothing to do with my parents, creating them or anything else they achieved. So when I say good things about them, I'm not patting myself on the back the way I might be implicitly if I said that about children that I made. And he was really a very special scholar. And he was a very serious academic.

And he was my best friend for-- we were best friends for the last 40 years of his life. I knew him longer, but when I was younger-- you know, young men and their fathers sometimes aren't always as close. But we were very good friends, and he was a great influence on my life.

INTERVIEWER: Before we move ahead, was having an academic for a parent like that, were you exposed to a lot of big ideas, too, as a kid? Did you understand what your father, as a as a young man, or before college, did you understand what he did?

MERTON: I had a reasonable understanding. I wasn't trained in it, but I absorbed it. Obviously there were many eminent academics that were part of my culture, so I knew a lot about the academic life. He created the field of sociology of science. So I had a lot of understanding about science as a social system, as a rewards system in science, how it works in the sense of functioning. I absorbed some of the concepts. But he didn't spend time training me or anything.

INTERVIEWER: That's very interesting. I mean, I think that's probably just what you're talking about. It's a thing a lot of who went into science lack, that sort of meta-understanding of the system.

MERTON: But he knew about everything. We were surrounded by books. I had thousands of books in my house. I had reference dictionaries and things in all the languages and all that sort of thing. Not that that did me any good, the other languages. But I was surrounded by books, and I'm sure that influenced my life as well. So it was a big influence, that's for sure.

INTERVIEWER: You studied mathematics and engineering. You decided to go into that for undergraduate. Engineering mathematics?

MERTON: Engineering mathematics, which was at that time, a relatively new field. And it gave me the freedom-- I mean, I loved applied mathematics. I took some pure mathematics, of course, but the truth was, I loved applied mathematics. I liked using it. I liked the way the structures worked. I got to take almost every kind of engineering, because the idea was, your tool is that you had to understand the language, not just the mechanical, electrical, civil materials, whatever. And so that gave him a breadth there. Columbia required all of us engineers to do things like contemporary civilization, humanities, English. In fact, my first published paper was in English literature.

INTERVIEWER: Wow. On what?

MERTON: Well, it was on Gulliver's Travels, of all things. It's a little strange. I was a sophomore, and I was taking an English course which I had to take, and they made you write every week, and I was terrible. I hated it. I couldn't come up anything. They said, write something creative. And of course, you know, my mind was blank, and the grades were reflective of that.

And then he had us read Gulliver's Travels, and we had to do a term paper of some sort. And in looking at one part of that dealing with the island of Laputa, how it worked-- as you know, Swift was a satirist. And he was always making fun of politicians, or Royal Society in particular. The island of Laputa was thought to have been a satirical treatment of the Royal Society of London. And he didn't seem to have much taste for these scientists. They had all their theories, but nothing worked.

And so I read this, and I, just reading his words, saw that-- he described how the island worked. If you actually followed the way he said the island worked, the island would crash. And he didn't need 20th century physics for that. It was-- you could take a pencil and just do the pencil like it was the island, and you'd see it would crash. So I thought that was kind of neat. And that was a different interpretation. I wrote that up for my term paper.

And I turned it in, and I remember, the teacher was an instructor. Because there were so few positions open in English that you didn't even get on tenure track for years. And I remember him coming up to me and saying, I think we have a good paper here. And this is, again, where I had the good fortune to have my father for advice. And I went and said, well, this guy hasn't done anything. Why is it our paper now? And is this is the way you do things? He said, no. You don't have to do that.

So I got my nerve up and told my teachers that it was my paper. I got a very poor grade in the course, but the paper got published in the Journal of the History of Ideas, which is a blue ribbon journal. And so in fact, my first published paper was-- I was 19. It was in English literature. So it sort of stands out as a little different from my later work.

INTERVIEWER: Was that your first and last paper in English literature?

MERTON: Yes, it was. You know, it's like forecasting. If you get it right once, you retire, because it doesn't get any better. And I didn't think that was going to happen again.

INTERVIEWER: That's very funny. So you ended up, you went to Caltech, right, for a bit? How did that--?

MERTON: Well, how that worked is I applied to PhD programs in applied math. And I applied to MIT and to Caltech, and I got in both places. Caltech gave me a full fellowship. MIT wanted me to be a TA as well. And I kind of like Southern California, and my brother-in-law had been a professor at Caltech. So I went to Caltech.

And I went out there to do it, and I had had a lot of mathematics as an undergraduate. Because Columbia let me-- I took six, seven courses a term. Not to show up, but they just let me do it. I took all kinds of courses, but lots of mathematics as well, because I just took so many.

So I had a lot of math when I got there, and so I was able to do all of coursework and to my qualifiers the first year. And toward the end of that, it was really in the-- oh, I guess after the first semester going into the second semester, I could see I'd have to start thinking about a thesis topic. I mean, Ihad to take qualifiers, but you know. And I was looking at the projects, the kinds of things the people were doing. It was kind of water waves in a tank, or plasma physics. And I had no passion for any of that.

And what was I doing? I was getting up every morning-- because it's 6:30 in California when it's 9:30 when the markets open in New York. I was trading for a couple of hours every morning before going to class, and then doing my classwork, working on my research, and then going in the morning, and-- but what really influenced me to think about it, was at this period of time-- this was in 1966, '67-- this was a period in which it was believed that we had solved the macroeconomic problems. I'm smiling because here we are, 40 later in this mess. But there was-- so this is back to the future. I've lived long enough to live through this at least twice.

But at that time, there was a belief that we had solved the big macro problems. Which was, we had policies that we could implement that would protect us against depressions or even big recessions and against inflations and out of control things. So the extremes. We still didn't know how to do what they call fine-tuning, but the big events, we thought we knew.

INTERVIEWER: It's like '67?

MERTON: '66, '67. And this had gone back to Walter Heller under Kennedy, and then Johnson. And I didn't really know. I had never had an economics course, a formal one. And I read about this, but I thought that was fascinating.

And then I read a really bad book on mathematical economics. I didn't know it was a bad book. I got it in the bookstore. And I read it and I said, gee. You know, I think I could do something in this area. If I'd gotten a good book, Ken Arrow or Paul Samuelson, I might have been intimidated. But I got a bad book, so I thought I could do something. Now, this is true. I didn't know.

So I started to begin to think about what I really wanted to do. And it comes back to this issue of passion. Passion was what was getting me up into that board room 6:30 in the morning and I watched. I did everything kind of transaction under the sun. I did convertible bonds, I borrowed money, I did options over the counter. There weren't even markets. I did everything.

INTERVIEWER: Was this something that, like, other guys your age were doing? You're just like the only one?

MERTON: No, I was the only one. I'm the only one I knew of. I'm sure there were other--

INTERVIEWER: Did you tell people what you were doing, or were you kind of secret about it?

MERTON: Well, I didn't advertise it. You know, this is at a time when this was not-- you know, it's like poker, we were talking about? Poker today, you know, with the World Series of Poker and so on on TV, in fact, some guy I used to play with here in Boston won the World Series. So you know, it's a big get TV thing now. So it's an appropriate thing. But poker was always one of those things, you know, if people ask you in good academic circles-- although there are plenty of academics who play, it's much more appropriate to say, I play chess. You don't say, I'm a poker player. You know? And the same thing with the stock market. That even Keynes, when he told the story about how he made all this money for his college, lying in bed in the morning, citing which bonds to be brought before his real work-- the whole idea was, if you did it for good cause, but it should be effortless. Never devote any real energy to something like that.

And there was a very big distinction at that time between business schools, or finance, or things like that, and other parts of economics. It's not that the stock market wasn't studied. But somehow business and other things was not thought of as an academic discipline.

INTERVIEWER: Interesting.

MERTON: You know, it was a very different way than it is now, 40 years later. So in that context, you asked the question, yeah, no, I didn't go out and say, hey, guess what I've been doing, or am doing. It was more secret.

But to get back to the main point-- it was clear, it was revealed that I had a passion about it. I thought about it. I thought about it not because anyone told me to. It was always there in my mind.

And so I had this idea, I said, well, I love mathematics. I've been doing a program. I do all kinds of stuff. Maybe what I ought to do is go into the field of economics, bring all these tools that I had in mathematics, and apply them to solve economic problems. And while I haven't had any economics-- so you can see this is a bit-- maybe a little bit, I hope not arrogant, but rather naive, maybe.

But in any case, I did feel I had a sense for it. I knew I had a passion for at least this part of it. But what inspired me is, if you do a little bit good, if you add a little bit, you can impact millions of people for a long time. And that's kind of cool. And that's what has happened. You had this vision-- at least that was the claim-- they had solved these major macroeconomic problems. And this would matter to millions of people. And I said, wouldn't that be kind of neat? So this is one of those things we all have that starts as a little thought here, and it keeps growing and growing and growing. And eventually I said, this is what I'm going to do.

So then I went to my advisor at Caltech and said, I've decided I'm going to apply to economics programs and change fields. And he told me I was crazy. And then I told my family. And they also thought I was probably a bit crazy. But no one, they weren't going to-- But so I did. So I applied to either eight or nine schools, including Columbia, where I had come from. Everybody but one turned me down. So it was easy decision.

The one that took me in was actually MIT. Probably the best department in the world, or the second best, who cares. And they give me full fellowship. So you apply to eight or nine places. They all said, well, who was this person? Because at that time, it was not a norm for people to switch fields like that, to take mathematics and apply to a graduate program in economics or other things. It just wasn't done. And so I'm sure they looked at me a bit crazy. And it was pure luck, or coincidence, or serendipity, if you like, that I got into MIT. And that was in itself an interesting story.

But I got in. I knew the names, Paul Samuelson and Bob Solow, but not much more, because I hadn't studied it. And since it was the only one anyway, it was a pretty easy decision.

So they let me get a degree at Caltech for my work. I got a Master's degree. And I lifted up, left California, and came back here to Cambridge.

INTERVIEWER: It's interesting because that story isn't totally unusual at MIT. MIT does seem to have this way of, or the ability to take people out of different fields and put them into other fields if they see promise or interest. And I mean, does that-- they're willing to take risks on smart people.

MERTON: Well, I'd like to say it's-- first of all, I'm sure you're correct, because I've known many people here at MIT who have had that experience. But I think in this case, it may have been a little more localized. I didn't know it, but there was a professor in the economics department, Harold Friedman, who was a statistician by training. Had been there forever. Before Paul Samuelson came to MIT, so he predated Paul Samuelson. I don't even think he had a PhD. And he apparently was on the graduate admissions committee.

And so when he saw my application, he recognized, first of all the mathematicians who had written for me. Secondly, because I had gotten into MIT in applied mathematics, what happens then is my previous application got shipped over so he could see what the people at MIT thought. And he said, why don't we take a flyer on this guy? I mean, I found this out, of course, later.

And that's probably the true story. If Harold Freeman hadn't been here, MIT probably-- you know, it's the best department in the world. So why take a flyer on someone when you can get all these great people? I might not have gotten in here either. So if he hadn't been there.

And then Harold, as an aside, deserves, if he hasn't gotten it, a very definite spot here in MIT, especially as it goes to the development of economics and the economics department. Because I found out later that he was instrumental in convincing Paul Samuelson to come. That he took a big part in trying to get Bob Solow to come. And then in my case, I told you already got me in as a graduate student.

But then the second part-- because this is a Harold Friedman story, not about me. When I showed up to register, you know, I was very contrite. Because I said, look, I've had no economics. So I had read what I was supposed to take, and I dutifully had said micro, macro, economic history, and so forth. I wrote it down. Guess who the graduate officer was I met? It was Harold Friedman.

And he looked at this. And I can remember this to this day. He looked at this thing. He has this big shock of white hair. He looked at this, and he looked at me, and he said, if you take these courses, you're going to be so bored by the end of the semester, you'll leave. And I said, well-- he says, why don't you go over and take Paul Samuelson's mathematical economics course? So I say, well, I haven't had any economics. He says, go take it anyway. It was a second year course.

So of course I said yes. I did what I did. And as a result, I went on, I signed up, my first semester here for Paul Samuelson's mathematical economics course. And I ended up running my economics sort of backwards, because I ended up taking the advanced course. And because of my mathematics training, the mathematics was quite comfortable for me. And I learned economics working backward. Along with some intuition, that I said, I think I just had an insight for that.

But I learned it that way. So I learned the advanced course first, and I did it with him. And it was a great experience. I took the other course as well, but I took this one. And at some point, he asked me, would I look at the paper he had written using Hamiltonian optimization equations and so forth. And being a graduate student, I said, of course, you know?

And then I took this thing, and I can tell you. I worked on this paper-- because he'd just handwritten all these equations-- I worked on this paper literally all night. I went over it and over it and over it, correcting as much as I could find, because I didn't want to miss anything. And then I got some sleep.

The next day I came, and I remember, I brought it to him. And I tried as much as I could-- you know, I was this kid-- I said, yes, well, I did go over it a little bit. Like I didn't say I was up all night. Gave it to him. And he came back to me, and he says, how would you like to work for me?

And so out of that course, I did the exam, but I also wrote a paper for the course, which was my first published paper. My term paper got published in economics, so that was nice. And then he hired me, just right there, my first semester. And I basically moved into his office. And I lived in Paul Samuelson's office for the rest of my graduate training.

So how could one have a better education? Being at MIT with all the great economists that were here, and the whole Institute as a frame, I felt very comfortable here. Because it was the Institute, because of the quantitative, the math, everything. You know, the engineering seemed fine to me. But the economics, you know, I lived there.

So when I look at these things--and I guess everyone has this experience. There were these little things that could have gone the other way, and my path would have been totally different. And it would have been some path, so it's not completely random. But none of this is going by the script of how it's all supposed to work.

INTERVIEWER: Yes. What was Samuelson like as a mentor? He seems like a good guy.

MERTON: We get along very well. And to say he was a very smart man is sort of a silly thing to say about him, since he was-- I don't know if you want to use the word "genius" or not. It's an overused word. But he was really--

INTERVIEWER: A giant, in any case.

MERTON: A giant, but we got along very well, and I never felt intimidated by him at all. And what was wonderful-- he was responsible for creating the notion of the sort of open door policy. His office was open. If Samuelson's door was open for students or colleagues, who should have their door closed? So it set a whole cultural thing there.

But I remember. His office-- this was in the '60s-- was in one spot, and Bob Solow's office was sort of next to it, on the side. And there'd be a big line of students to see Solow, and no one to see Samuelson. So I said, fantastic. I just get all this free time with him. And later on, I found out there was a certain intimidation factor, apparently.

But I just had a great time. We talked. And then we found out we had this common interest in the stock market. And he had written a paper on warrant pricing, and I knew all about warrants, because I traded them, and I got into it. And that's when I first found out that what I had been doing all this time, on some level, since I was 10 years old-- all the stuff on the stock market, and warrants, and convertible bonds and everything-- I could actually do that as a day job. It was actually something I could do serious research on. It was a challenging problem, because finance is all about uncertainty. It's all about things over long periods of time, and it's all about optimization. So the kinds of problems you have are dynamic optimization under uncertainty, where you're having to deal with issues that go way, way out into the future.

Intellectually, I loved calculus of variation. I loved all the techniques for that kind of optimization. And so technically, and in terms of just sheer intrinsic excitement, the challenges of the problem were just wonderful in this field.

INTERVIEWER: That must have a great moment when it all clicked, and you're like, whoa!

MERTON: Yeah. And he just took me in, and I understood this stuff. I ended up running a little bit of money with him, for him.

INTERVIEWER: How did you do?

MERTON: I think we did all right. He had better ones that he had. He had students that created great fortunes. But no, it worked fine. The stuff all worked. I just don't want to suggest that we made great fortunes with it or anything, but it was fine.

But I learned a lot. And turned out, being engaged in the markets, even though I really didn't know what I was doing-- I thought I did-- was such a powerful thing for a young person. Because in all of the science I know if, but models, or things you build to try to describe the rule of the world, by their nature have to be abstractions from complex reality. They have to be simplifications.