------------ EH.NET BOOK REVIEW --------------  
Published by EH.NET (November 2005)  
  
Donald R. Stabile, _Forerunners of Modern Financial Economics: A   
Random Walk in the History of Economic Thought, 1900-1950_.   
Cheltenham, UK: Edward Elgar, 2005. viii + 173 pp. $85 (hardcover),   
ISBN: 1-84542-101-9.  
  
Reviewed for EH.NET by Geoffrey Poitras, Faculty of Business   
Administration, Simon Fraser University.  
  
  
Book reviews tend to say more about the reviewer than the book. It is   
possible to find fault in the most innovative contributions and to   
find kernels of value in misguided, pedestrian efforts. This short,   
delightful book by Donald Stabile is a case in point. While it is   
possible to criticize the numerous minor inaccuracies and   
inconsistencies in the presentation, this is to be expected from a   
book without equations dealing with the inherently mathematical   
subject matter of modern financial economics. Similarly, there is a   
decided lack of cohesion in the individuals selected for presentation   
-- such as Thorstein Veblen, Irving Fisher and Benjamin Graham. Given   
the absence of studies on the intellectual antecedents to modern   
financial economics covering the 1900-1950 period, this lack of   
cohesion is understandable. Those seeking deep insight into important   
themes, such as the study of investment risk by economists will be   
disappointed. Achieving this objective is too much to expect from a   
small book that covers so much ground.  
  
As exemplified by Rubinstein (2003, p. 1041), purists of modern   
financial economics maintain that "the moment of birth of modern   
financial economics" is the publication of Markowitz (1952). Stabile   
(p. 9) uses this assessment to define the goal of his book: "to   
document the efforts of a small number of economists who had   
discovered what Markowitz made conventional: stock market price   
changes can be treated as a random variable to be analyzed with   
statistical tools." With the statistical element in mind, Stabile   
recognizes the important distinction between Bayesian and frequentist   
approaches to statistics. Throughout the book, Stabile aims to trace   
the intellectual foundations of modern financial economics to those   
that used Bayesian methods to analyze financial markets, even if such   
individuals are not typically recognized as Bayesians. This theme is   
so central to the book that, after an introductory chapter, the   
second of nine chapters is dedicated to developing the progress of   
Bayesian analysis within economics.  
  
Recognizing the superiority of the Bayesian over the frequentist   
approach in analyzing financial markets is an excellent avenue for   
exploring the distinction between risk and uncertainty -- a topic   
that is addressed at various points in chapters 5, 7 and 9. Because   
this distinction plays no substantive role in modern financial   
economics, a useful connection is made to the subject of chapter   
three: Irving Fisher's theory of capital under both certainty and   
risk. Though Stabile makes a half-hearted attempt to argue that   
Fisher was in the Bayesian camp, the story is not much affected   
whether he is a frequentist or not. The essence of Fisher's seminal   
contribution to laying the foundations of modern financial economics   
is ably, if somewhat superficially, developed. In the process,   
various interesting stories and anecdotes from Fisher's life are   
provided. Because Fisher was a leading academic who had the   
misfortune of unsuccessfully seeking recognition from the vernacular   
side of finance, these stories will be of inherent interest to   
sociologists of intellectual history.  
  
The stories and anecdotes about the various forerunners of modern   
financial economics are one of the desirable features of this book.   
For example, the personal investment strategies of both Keynes, in   
chapter 7, and Fisher, in chapter 3, are examined in detail to reveal   
that in making personal financial investment decisions neither was   
close to being an adherent to the diversification principle. The   
large number of forerunners identified in the book provides a number   
of stories to draw upon. In addition to Fisher and Keynes, the list   
of forerunners examined includes: Frank Knight, Benjamin Graham, John   
Burr Williams, Alfred Cowles, Edgar Lawrence Smith, Frederick   
Macaulay, Wesley Mitchell, and Herbert Davenport. The latter two   
names are motivated by the inclusion of a most unlikely forerunner:   
Thorstein Veblen. As Veblen's contribution is afforded a whole   
chapter, the only individual other than Fisher to warrant a complete   
chapter, this odd selection requires considerable justification.   
While the justification provided is rather thin, Veblen does provide   
a connection to alternative approaches to financial economics that   
would not otherwise surface.  
  
Despite recognizing Veblen, the possibility of providing a less   
conventional view of the history of modern financial economics goes   
largely undeveloped in this book. Undoubtedly, Veblen would be very   
uncomfortable with the mathematical world populated by the   
homogeneous rational investors portrayed in modern financial   
economics. Veblen is closer to modern sociologists than to modern   
financial economists such as Markowitz or Fama. Along this line,   
sociologists of intellectual history, such as Preda (2003), employ a   
distinction between vernacular and academic theories of finance. This   
distinction could have been used to establish incongruence between   
the vernacular views of the 'old finance,' as reflected by Benjamin   
Graham, and the academic theories of modern financial economics.   
Instead of viewing Graham as a forerunner of modern financial   
economics, the conflict between the academic and the vernacular   
approaches, identified in Haugen (1999) and Poitras (2005), could   
have been properly situated.  
  
In the end, _Forerunners of Modern Financial Economics_ is a short   
book with a number of attractive features. The subject is treated in   
an introductory fashion and the text is pleasant to read. Various   
fascinating intellectuals from the 1900-50 period that contributed,   
in some significant fashion, to financial economics are identified.   
Interesting anecdotes and stories from the lives of those examined   
offset the somewhat questionable and loosely conceived interpretation   
of the different contributions. The weakest aspect of the book is the   
unquestioning acceptance of the claim that modern financial economics   
begins with Markowitz (1952). If correct, this claim is restricted to   
the academic realm. No attention is given to identifying the   
practical or vernacular impact of the key elements of modern   
financial economics: "the efficient markets theory, the belief that   
stock price changes are random, and the study of investment risk" (p.   
4). But exploring this comment further risks saying more about this   
reviewer than about the book.  
  
References:  
  
R. Haugen, _The New Finance: The Case against Efficient Markets_   
(second edition), Upper Saddle River, NJ: Prentice-Hall, 1999.  
  
H. Markowitz, "Portfolio Selection," _Journal of Finance_ (1952): 77-91.  
  
G. Poitras, _The Early History of Financial Economics: 1478-1776_,   
Cheltenham: Edward Elgar, 2000.  
  
G. Poitras, _Security Analysis and Investment Strategy_, Oxford:   
Blackwell Publishing, 2005.  
  
A. Preda, "Informative Prices, Rational Investors: The Emergence of   
the Random Walk Hypothesis and the Nineteenth Century 'Science of   
Financial Investments'," _History of Political Economy_ (2003):   
351-86.  
  
M. Rubinstein, "Great Moments in Financial Economics: II.   
Modigliani-Miller Theorem," _Journal of Investment Management_ (2003).  
  
  
Geoffrey Poitras is a Professor of Finance in the Faculty of Business   
Administration at Simon Fraser University, Burnaby, BC, Canada. He   
has published widely in the areas of derivative securities, security   
analysis, and risk management. He is also the author of _The Early   
History of Financial Economics, 1478-1776_ (2000) and is editor of   
the two volume _Pioneers of Financial Economics_ to appear soon from   
Edward Elgar.  
  
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