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Professor Stephen A. Ross, Inventor of Arbitrage Pricing Theory, Dies at 73

Ross, who joined MIT Sloan in 1997, relished the practical use of finance theory

Stephen A. RossStephen A. Ross

MIT Sloan Professor Stephen A. Ross, inventor of the arbitrage pricing theory and a foundational member of the practice of modern finance, died Friday, March 3, 2017. He was 73. Ross, the Franco Modigliani Professor of Financial Economics, was best known for his arbitrage pricing theory, developed in 1976. The theory, commonly known as APT, is used to identify and exploit mispriced assets by tracking a number of macroeconomic factors. It serves as a framework for analyzing risks and returns. The APT is widely applied in investment management practice today. Ross is also responsible for the economic theory of agency and was the co-creator of the Cox-Ingersoll-Ross model of pricing government bonds and the binomial model for pricing options.

Those theories and models are cornerstones of neoclassical finance, a field which Ross pioneered and defended in a 2004 book of the same name. MIT Sloan Professor Leonid Kogan, a former student, co-authored the behavioral economics-based “The Price Impact and Survival of Irrational Traders” in the Journal of Finance with Ross in 2006.

“Steve was a scholar. If the model tells you otherwise and the results go against his beliefs, he updates his beliefs,” Kogan said. “His main position wasn’t dogmatic. He was trying to get to the truth.”

More recently, Ross developed the recovery theorem, which allows the separation of probability distribution and risk aversion to forecast returns from state prices. His current research “focused on applying the recovery theorem to existing option pricing data, extending the recovery approach to fixed income markets, and using options to improve the performance of institutional portfolios,” according to his biography on MIT Sloan’s website.

“Steve Ross will be remembered as an intellectual giant,” MIT Sloan Dean David Schmittlein wrote in a message to the MIT Sloan community. “What is known today about the science of finance and its application owes much to Steve’s pioneering work, ranging from asset pricing to investment management to corporate finance. Steve did not believe in narrow specialization and intellectual boundaries. It is difficult to imagine the discipline of modern finance without Steve’s contributions.”

“Steve Ross was one of the giants of modern finance with a razor-sharp intellect and a heart of gold,” said MIT Sloan Professor Andrew W. Lo. “The cold, hard logic of his mathematical theories stood in sharp contrast to the warmth of his personality. He was more humanist than financial economist, and was deeply connected in so many communities that would rightly claim Steve as their own. This is an enormous loss to MIT and the world.”