In 1970, in his Fundamentals of Liquidity, Fischer Black discusses slicing off the various forms of risk found in a single corporate bond:
Thus a long term corporate bond could actually be sold to three separate persons. One would supply the money for the bond; one would bear the interest rate risk, and one would bear the risk of default. The last two would not have to put up any capital for the bond, though they might have to post some sort of collateral.
In case that doesn’t freak you out, Mike Rorty says, that’s from 1970, and it predicts everything:
It’s before the Black-Scholes Equation (same Black) is published and popularized, creating the derivative market, so it is during the first wave of thinking how derivatives would change everything.He’s saying, in the far future, there will be a market for slicing off the interest rate risk on a bond. There is such an instrument, the interest rate swap, and that market was created in the 1980s. He’s also saying the risk decomposition could be completed by slicing off the credit risk and selling that wholesale. That’s the credit default swap, or the CDS you always hear about, and that was created in the 1990s and popularized in the 2000s. This is the complete market that lead us into the current credit crisis, and here is Fischer Black 28 years beforehand, a consultant at Arthur D. Little at the time, explaining exactly how it would go.
What Black does not predict is the difference between markets in theory and markets in practice.