The Black-Scholes formula had passed the market test. But as banks and hedge funds relied more and more on their equations, they became more and more vulnerable to mistakes or over-simplifications in the mathematics.
"The equation is based on the idea that big movements are actually very, very rare. The problem is that real markets have these big changes much more often that this model predicts," says Stewart. "And the other problem is that everyone's following the same mathematical principles, so they're all going to get the same answer."
Now these were known problems. What was not clear was whether the problems were small enough to ignore, or well enough understood to fix. And then in the late 1990s, two remarkable things happened.
"The inventors got the Nobel Prize for Economics," says Stewart. "I would argue they thoroughly deserved to get it."http://www.bbc.co.uk/news/magazine-17866646