Advertisement

The Emergence of Modern Financial Economics

  • Alessandro VercelliEmail author
Chapter

Abstract

The author argues that the evolution of the financial system and the contemporaneous co-evolution of financial economics exerted a deep mutual influence on each other. After WWII, this branch of economics slowly acquired the status of autonomous sub-discipline having its own rigorous paradigmatic hallmarks (Modern Financial Economics), and assumed a growing influence on both macroeconomics and the real world. The new approach to financial issues provided a sanguine view of financial firms, markets, and institutions appealing to mainstream researchers for its analytic potential, policy makers for its support to the emerging neoliberal views, and practitioners for its operational approach that encouraged and justified an exponential growth of financial trade. The author discusses strength and shortcomings of the main building blocks of Modern Financial Economics focusing in particular on the foundational role of the Efficient Market Hypothesis (EMH). The concluding remarks investigate why the alignment between the model predictions and markets behaviour discernible in tranquil times broke down in times of financial turmoil.

References

  1. Bachelier, Louis. 1900. Théorie de la spéculation. Annales Scientifiques de L’École Normale Supérieure 17: 21–86. English translation by A.J. Boness in Cootner, P.H., eds. 1964. The Random Character of Stock Market Prices. Cambridge, MA: MIT Press; 17–75.Google Scholar
  2. Berle, Adolf A., and Gardner C. Means. 1967 [1933]. The Modern Corporation and Private Property. 2nd ed. New York: Harcourt, Brace and World.Google Scholar
  3. Black, Fischer, and Myron Scholes. 1972. The Valuation of Option Contracts and a Test of Market Efficiency. Journal of Finance 27 (2): 399–418.CrossRefGoogle Scholar
  4. ———. 1973. The Pricing of Options and Corporate Liabilities. The Journal of Political Economy 81 (3): 637–654.CrossRefGoogle Scholar
  5. Black, Fischer, Michael C. Jensen, and Myron Scholes. 1972. The Capital Asset Pricing Model: Some Empirical Tests. In Studies in the Theory of Capital Markets, ed. Michael C. Jensen, 79–121. New York: Praeger.Google Scholar
  6. Chan, K.C., and Nai-Fu Chen. 1991. Structural and Return Characteristics of Small and Large Firms. Journal of Finance 46 (4): 1467–1484.CrossRefGoogle Scholar
  7. Coase, Ronald. 1937. The Nature of the Firm. Economica 4 (16): 386–405.CrossRefGoogle Scholar
  8. Fama, Eugene F. 1965a. The Behavior of Stock Market Prices. Journal of Business 38 (1): 34–105.CrossRefGoogle Scholar
  9. ———. 1965b. Random Walks in Stock Market Prices. Financial Analysts Journal 51 (1): 55–59.CrossRefGoogle Scholar
  10. ———. 1970. Efficient Capital Markets: A Review of Theory and Empirical Work. Journal of Finance 25 (2): 383–417.CrossRefGoogle Scholar
  11. ———. 2011. My Life in Finance. Annual Review of Financial Economics 3 (1): 1–15.CrossRefGoogle Scholar
  12. Fama, Eugene F., and Kenneth R. French. 1992. The Cross-Section of Expected Stock Returns. The Journal of Finance 47 (2): 427–465.CrossRefGoogle Scholar
  13. ———. 2004. The Capital Asset Pricing Model: Theory and Evidence. Journal of Economic Perspectives 18 (3): 25–46.CrossRefGoogle Scholar
  14. Fama, Eugene F., Lawrence Fisher, Michael Jensen, and Richard Roll. 1969. The Adjustment of Stock Prices to New Information. International Economic Review 10 (1): 1–21.CrossRefGoogle Scholar
  15. Farmer, Doyne J., and Andrew W. Lo. 1999. Frontiers of Finance: Evolution and Efficient Markets. Proceedings of the National Academy of Sciences of the United States of America 96 (18): 9991–9992.CrossRefGoogle Scholar
  16. Graham, Benjamin, and David L. Dodd. 1934. Security Analysis. New York: McGraw-Hill.Google Scholar
  17. Grunberg, Emile, and Franco Modigliani. 1954. The Predictability of Social Events. The Journal of Political Economy 62 (6): 465–478.CrossRefGoogle Scholar
  18. Holt, Charles C., Franco Modigliani, John F. Muth, and Herbert A. Simon. 1960. Planning Production, Inventories, and Work Force. Englewood Cliffs: Prentice Hall.Google Scholar
  19. Honoré, Anthony M. 1961. Ownership. In Oxford Essays in Jurisprudence, ed. Anthony G. Guest. Oxford: Oxford University Press.Google Scholar
  20. Jensen, Michael C., and William H. Meckling. 1976. Theory of the Firm: Managerial Behavior, Agency Costs, and Ownership Structure. Journal of Financial Economics 3 (4): 305–360.CrossRefGoogle Scholar
  21. Kay, John. 2015. Shareholders Think They Own the Company—They Are Wrong. Financial Times, November 10.Google Scholar
  22. Kendall, Maurice G. 1953. The Analysis of Time Series. Part 1: Prices. Journal of the Royal Statistical Society Series A (General), 116 (1): 11–25.Google Scholar
  23. Lakatos, Imre. 1970. Falsification and the Methodology of Scientific Research Programmes. In Criticism and the Growth of Science, ed. Imre Lakatos and Alan Musgrave, 91–195. Cambridge: Cambridge University Press.CrossRefGoogle Scholar
  24. Lazonick, William. 2017. Innovative Enterprise Solves the Agency Problem: The Theory of the Firm, Financial Flows, and Economic Performance, INET, Working Paper No. 62.Google Scholar
  25. Lintner, John. 1965. The Valuation of Risk Assets and the Selection of Risky Investments in Stock Portfolios and Capital Budgets. Review of Economics and Statistics 47 (1): 13–37.CrossRefGoogle Scholar
  26. Lo, Andrew W. 2007. Efficient Markets Hypothesis. In The New Palgrave: A Dictionary of Economics, ed. Lawrence E. Blume and Steven N. Durlauf, 2nd ed., 3543–3560. Basingstoke: Palgrave Macmillan.Google Scholar
  27. Mandelbrot, Benoit. 1963. The Variation of Certain Speculative Prices. The Journal of Business 36 (4): 394–419.CrossRefGoogle Scholar
  28. Markowitz, Harry M. 1952. Portfolio Selection. The Journal of Finance 7 (1): 77–99.Google Scholar
  29. ———. 1959. Portfolio Selection: Efficient Diversification of Investments. New York: John Wiley & Sons. (Reprinted by Yale University Press, 1970; 2nd ed. Basil Blackwell, 1991).Google Scholar
  30. ———. 1991. Foundations of Portfolio Theory. The Journal of Finance 46 (2): 469–477.CrossRefGoogle Scholar
  31. ———. 1999. The Early History of Portfolio Theory: 1600–1960. Financial Analysts Journal 55 (4): 5–16.CrossRefGoogle Scholar
  32. Marris, Robin. 1964. The Economic Theory of ‘Managerial’ Capitalism. London: Macmillan & Co Ltd.CrossRefGoogle Scholar
  33. Mehrling, Perry. 2005. Fisher Black and the Revolutionary Idea of Finance. Hoboken, NJ: John Wiley and Sons, Inc.Google Scholar
  34. Merton, Robert K. 1948. The Self Fulfilling Prophecy. Antioch Review 8 (2): 193–210.CrossRefGoogle Scholar
  35. Merton, Robert C. 1973. Theory of Rational Options Pricing. Bell Journal of Economics and Management Science 4 (1): 141–183.CrossRefGoogle Scholar
  36. ———. 2006. Paul Samuelson and Financial Economics. American Economist 50 (2): 9–31.CrossRefGoogle Scholar
  37. ———. 2013. Black-Scholes-Merton: A 40-year Revolution in Finance. Professor Robert Merton discusses the transformative financial model that won him the Nobel Memorial Prize in Economic Sciences, MIT Sloan School, October 2.Google Scholar
  38. Minsky, Hyman P. 1986. Stabilizing an Unstable Economy. New Haven and London: Yale University Press.Google Scholar
  39. Mittnik, S., S.T. Rachev, T. Doganoglu, and D. Chenyao. 1999. Maximum Likelihood of Stable Paretian Estimation Models. Mathematical and Computer Modelling 29 (10–12): 276–293.Google Scholar
  40. Modigliani, Franco, and Merton H. Miller. 1958. The Cost of Capital, Corporation Finance, and the Theory of Investment. American Economic Review 48: 261–297.Google Scholar
  41. Mossin, Jan. 1966. Equilibrium in a Capital Asset Market. Econometrica 35 (4): 768–783.CrossRefGoogle Scholar
  42. Muth, John F. 1961. Rational Expectations and the Theory of Price Movements. Econometrica 29 (3): 315–335.CrossRefGoogle Scholar
  43. Roberts, Harry V. 1959. Stock Market ‘Patterns’ and Financial Analysis: Methodological Suggestions. Journal of Finance 14 (1): 1–10.Google Scholar
  44. Roll, Richard. 1977. A Critique of the Asset Pricing Theory Test, Part I: On Past and Potential Testability of the Theory. Journal of Financial Economics 4 (2): 129–176.CrossRefGoogle Scholar
  45. Roy, Andrew D. 1952. Safety First and the Holding of Assets. Econometrica 20 (3): 431–449.CrossRefGoogle Scholar
  46. Samuelson, Paul A. 1947. Foundations of Economic Analysis. Harvard University Press. (Enlarged ed., 1983).Google Scholar
  47. ———. 1965. Proof That Properly Anticipated Prices Fluctuate Randomly. Industrial Management Review 6 (2): 41.Google Scholar
  48. ———. 1970. Maximum Principles in Analytical Economics. Nobel Memorial Lecture, December 11.Google Scholar
  49. ———. 2009. An Enjoyable Life Puzzling Over Modern Finance Theory. Annual Review of Financial Economics 1 (1): 19–35.CrossRefGoogle Scholar
  50. Scherer, Bernd. 2002. Portfolio Resampling: Review and Critique. Financial Analysts Journal 58 (6): 98–109.CrossRefGoogle Scholar
  51. Sharpe, William F. 1964. Capital Asset Prices: A Theory of Market Equilibrium under Conditions of Risk. Journal of Finance 19 (3): 425–442.Google Scholar
  52. Shiller, Robert. 1978. Rational Expectations and the Dynamic Structure of Macroeconomic Models: A Critical Review. Journal of Monetary Economics 4 (1): 1–44.CrossRefGoogle Scholar
  53. Stiglitz, Joseph E. 2000. Economics of the Public Sector. 3rd ed. New York and London: W.W. Norton and Co.Google Scholar
  54. Stout, Lynn A. 2013. The Shareholder Value Myth. Cornell Law Faculty Publications. Paper 771. http://scholarship.law.cornell.edu/facpub/771. Accessed 10 Oct 2018.
  55. Tobin, James. 1958. Liquidity Preference as Behaviour Towards Risk. Review of Economic Studies 25 (2): 65–86.CrossRefGoogle Scholar
  56. Treynor, Jack L. 1961. Market Value, Time, and Risk. Unpublished Manuscript. Available at SSRN: https://ssrn.com/abstract=2600356 or  https://doi.org/10.2139/ssrn.2600356. Accessed 15 June 2018.
  57. ———. 1962. Toward a Theory of Market Value of Risky Assets. Unpublished Manuscript. Available at SSRN: http://ssrn.com/abstract=628187. Accessed 15 June 2018.
  58. Vercelli, Alessandro. 1991. Methodological Foundations of Macroeconomics. Keynes and Lucas. Cambridge: Cambridge University Press.Google Scholar
  59. ———. 2017. Crisis and Sustainability. The Delusion of Free Markets. London: Palgrave Macmillan.Google Scholar
  60. Working, Holbrook. 1934. A Random-Difference Series for Use in the Analysis of Time Series. Journal of the American Statistical Association 29 (185): 11–24.CrossRefGoogle Scholar

Copyright information

© The Author(s) 2019

Authors and Affiliations

  1. 1.University of SienaSienaItaly

Personalised recommendations