------------ EH.NET BOOK REVIEW --------------
Published by EH.NET (October 2007)

Geoffrey Poitras, editor, _Pioneers of Financial Economics: Volume 2, 
Twentieth-Century Contributions_. Edward Elgar: Cheltenham, UK, 2007. 
x + 244 pp. $130 (cloth), ISBN: 978-1-84542-382-7.

Reviewed for EH.NET by Ramon P. DeGennaro, Department of Finance, 
University of Tennessee, Knoxville.


_Pioneers of Financial Economics: Volume 2_ is arranged in three 
parts. Part I is titled "Early Contributions." My favorite chapter in 
this section is Robert W. Dimand's discussion of Irving Fisher and 
his students. This is partly because the chapter is so well done, 
partly because Fisher did so much, and partly because Fisher could be 
so audacious at times. Part II is titled "The Modern Finance 
Revolution: The Inside Perspective." If forced to choose among the 
five fine articles in this section, Hal Varian's article about Harry 
Markowitz, Merton Miller and William Sharpe would be a narrow winner. 
Varian is simply a gifted writer who successfully translates these 
Nobel laureates' work into concise, clear language, using a graph and 
only a few equations. Part III is titled "Alternative Perspectives on 
the Revolution." Here, my favorite is Donald MacKenzie's 
contribution, "The Emergence of Option Pricing Theory." This is 
entertaining because it conveys the process of discovery and the 
intellectual struggles that Black, Scholes and Merton endured. 
Getting from the idea to the famous Black-Scholes and Merton formula 
wasn't easy, even for them.

I enjoyed the articles and recommend the book particularly to 
economic historians and sociologists interested in the evolution of 
ideas. Prospective readers should be aware that this book has an 
agenda, though. This agenda becomes clear as early as the 
introduction, which throws down the gauntlet between what it calls 
"traditional finance" (it sometimes uses "old finance") and "new 
finance." The dividing line is approximately Markowitz's work or the 
Modigliani and Miller papers. There is no doubt which side the book 
favors and to its credit it makes no bones about it. It absolutely 
favors traditional finance. Part II, which in the context of this 
book champions new finance, contains four reprints and only one 
original contribution. The articles in the other parts of the book 
are new. This cannot be due to chance, especially given a revealing 
sentence about the reprints in the introduction: "Each of these 
chapters is an excellent example of the narrow interpretations of the 
intellectual history of financial economics and inflated claims for 
scientific significance common in modern financial economics" (12). 
Or this: "A key objective of Part II is to explore the process of 
prestige creation and reinforcement in modern financial economics" 
(8).

In short, a key reason for including the five chapters dedicated to 
new finance is to assert that those who write tributes to Nobel 
laureates within the field are making inflated claims, and to show 
that the prestige which the new finance enjoys is allegedly built on 
a house of cards. Readers will ask why, from among the tens of 
thousands of articles from which to choose, the book includes 
articles that it believes are deeply flawed, if not to grind the axe 
in a particular way?

If an attempt to frame _Pioneers of Financial Economics_ as a contest 
between traditional finance and new finance must be made, and if a 
winner must be chosen between them, readers would find the result to 
be more credible if the playing field were not so obviously tilted. 
For example, the book makes no effort to conceal its distaste for 
modern portfolio theory. By way of support it correctly notes that 
many market professionals still perform security analysis, which the 
book treats as the purview of traditional finance. But it rarely if 
ever mentions mutual funds, which are a trillion-dollar 
counterexample highlighting the success of portfolio theory. The many 
studies showing that indexing beats active management, far more often 
than not, are apparently too trivial to mention. The book claims 
that, "One of the oddities of modern financial economics has been the 
success of this movement in securing the academic high ground in the 
finance curriculum of business schools despite proving relatively 
sterile in practical implications." Such statements likely will 
persuade very few readers. They see that options and futures trading 
are booming, along with sophisticated risk management techniques. 
Banks and corporations routinely hedge using tools built on modern 
finance. Businesses design executive compensation contracts to 
include securities to align their incentives with other investors. 
Regulators invoke capital structure theory to require banks to issue 
securities designed to provide early-warning signals of financial 
distress. Investors hold mutual funds. Exchange-traded funds are 
growing rapidly. If the book wants to make a convincing case in a 
battle between old and new, it would do better to show that these 
innovations have their roots in traditional finance rather than 
simply to ignore them.

The choice of a post-Keynesian economist to write the final chapter 
is consistent with the book's slant. I do not believe that I am alone 
in thinking it strange to select a post-Keynesian economist to write 
the final chapter of a book on the pioneers of financial economics. 
This in no way minimizes or denigrates Keynes's contributions to the 
field of economics. They speak for themselves. The choice merely 
seems ... strange.

Given the agenda, a different title would work better. _In Defense of 
Traditional Finance_ would be just fine. Search engines would find 
the book for readers seeking such material, and casual library or 
bookstore browsers would know immediately what to expect when they 
pick up the book.

While I would have preferred that _Pioneers of Financial Economics_ 
had chosen a more balanced approach to the perceived battle between 
old and new, readers would have been still better served not to cast 
it as a contest at all. This battle is over and everyone knows who 
won. The proponents of old finance are sure that they won, the 
proponents of new finance are sure that _they_ won, and just about 
everyone is satisfied with this outcome. In truth, most of us have no 
time to take sides in battles outside of our specialty. Perhaps we 
would all benefit by borrowing from Kian-Guan Lim, who ends his fine 
chapter on the evidence in support of and against the Efficient 
Market Hypothesis by writing, "... we could also move on."


Ramon P. DeGennaro is the SunTrust Professor of Finance at the 
University of Tennessee. He also conducts research as a Visiting 
Scholar at the Federal Reserve Bank of Atlanta. He has published more 
than thirty-five refereed articles on financial market volatility, 
the term structure of interest rates, financial institutions, and 
investments. His other publications include research reports, book 
chapters and book reviews. The opinions in this article are his own 
and not necessarily those of the Federal Reserve Bank of Atlanta or 
the Federal Reserve System.

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