------------ 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.
Copyright (c) 2005 by EH.Net. All rights reserved. This work may be
copied for non-profit educational uses if proper credit is given to
the author and the list. For other permission, please contact the
EH.Net Administrator ([log in to unmask]; Telephone: 513-529-2229).
Published by EH.Net (November 2005). All EH.Net reviews are archived
at http://www.eh.net/BookReview.
-------------- FOOTER TO EH.NET BOOK REVIEW --------------
EH.Net-Review mailing list
[log in to unmask]
http://eh.net/mailman/listinfo/eh.net-review
|