Traders are keen to develop options on actively traded accounts, such as hedge funds. Alex Lipton-Lischitz’s pioneering work, published in Risk, has simplified the process

Alex Lipton-Lischitz, vice-president in the foreign exchange product development group at Deutsche Bank in New York, has only been working on Wall Street for three years, but his career in finance has already proved highly successful.

His first paper in Risk, ‘Passport to Success’, was published in September 1997. Co-authored by Lipton-Lischitz and Banker’s Trust colleagues Tom Hyer and Dmitry Pugachevsky, this breakthrough paper showed for the first time how to price passport options – options on an actively traded account. Within months of the paper’s appearance, some firms were drawing on this research and offering guaranteed products linked to hedge funds.

Lipton-Lischitz then wrote a paper entitled ‘Similarities and Self-Similarities’, which appeared in the September 1999 issue of Risk. In it, he described the use of techniques borrowed from theoretical physics to discern similarities between the pricing formulas for passport options, lookback options and Asian options. One of the academic referees for the paper described the re-derivation of the Asian option pricing formula using these techniques as “quite remarkable”.

The work in the paper was developed during the spring of 1999, when the merger between Bankers Trust and Deutsche Bank meant the research teams had time on their hands. According to Lipton-Lischitz: “We had known since 1997 that there were similarities between the pricing formulas for lookback options and passport options, which we had chosen to exploit. I saw a paper by Henderson and Hobson at the University of Bath who derived the same similarities using probabilistic methods. I realised that the similarities between these pricing formulas were not accidental.”

Lipton-Lischitz chose to use the technique of self-similarity, widely used in theoretical physics, to examine the problem further. The technique is used to reduce the number of parameters in a mathematical model to the minimum needed to represent a particular problem. By reducing problems to their essence, simpler solutions can be found and parallels between seemingly unrelated problems can become apparent. According to Peter Carr, quantitative analyst at NationsBanc Montgomery Securities: “Lipton-Lischitz’s emphasis on dimensionless variables economises the analysis, reveals important linkages, and has significant computational implications.”

In this year’s Risk paper, Lipton-Lischitz shows that the pricing formulas are similar for foreign exchange lookback put options, when foreign and domestic interest rates are zero, and passport options on a foreign exchange trading account when the foreign interest rate is zero. He shows that the price of the passport option should be one-half of the price of the lookback put option. He re-derives the pricing formula for Asian options in a very simple way and demonstrates similarities with the pricing formula for passport options when the foreign currency interest rate is non-zero.

In the final section of the paper he briefly examines similarities between imperfectly hedged European options, Asian options and passport options.

The technique of self-similarity has been used in the world of finance before, and Lipton-Lischitz sees it as having a wide application to financial problems. He is currently using the technique on the problem of pricing options on stocks paying constant dividends, and on pricing options in the presence of volatility smiles. More publications are expected.

After his PhD at the Moscow State University, Lipton-Lischitz began his career at the Russian Academy of Sciences, working on the physics of charged plasmas in the magnetosphere around the earth. In 1989, at the age of 32, Lipton-Lischitz was accepted into the US as a political refugee. There, he was able to find employment as a research associate at MIT. Within seven years Lipton-Lischitz had worked his way up the academic ladder to the position of full-tenured professor at the University of Illinois, still concentrating on problems in hydrodynamics and magneto-hydrodynamics.

Some contact with financial markets came through his wife, Marsha, who was working as a trader in New York after completing a PhD and MBA at the University of Chicago. It was only a matter of time before he too made the switch to finance.

There is a team of seven in the Deutsche Bank foreign exchange product development group under global head Chris Berry, divided between London and New York. Lipton-Lischitz spends one week out of six with Deutsche Bank’s traders in London, and the transatlantic flights give him time to keep up with some of the developments in his former research fields.

“ At Deutsche Bank we work very closely with the traders, as well as pursuing longer-term research,” he says. “ I find many financial problems just as interesting as the work I was pursuing in academia.” As well as working on pricing models, he has developed interests in risk management and asset management and in wider economic issues. He has also worked on real options – the application of option pricing techniques to real-world situations.

Lipton-Lischitz’s links with academia remain strong. He maintains the post of adjunct professor at the University of Illinois, and in the long term may consider moving back into the academic world. At the moment though he considers himself fortunate “to be paid for working on subjects I find so interesting”.

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