A History of the Theory of Investments E-Book

Mark Rubinstein

• Herausgeber: John Wiley & Sons
• Kategorie: Fachliteratur
• Serie: Wiley Finance Editions
• Sprache: Englisch

Seitenzahl: 709

Veröffentlichungsjahr: 2011

Beschreibung

"This exceptional book provides valuable insights into the evolution of financial economics from the perspective of a major player." -- Robert Litzenberger, Hopkinson Professor Emeritus of Investment Banking, Univ. of Pennsylvania; and retired partner, Goldman Sachs A History of the Theory of Investments is about ideas -- where they come from, how they evolve, and why they are instrumental in preparing the future for new ideas. Author Mark Rubinstein writes history by rewriting history. In unearthing long-forgotten books and journals, he corrects past oversights to assign credit where credit is due and assembles a remarkable history that is unquestionable in its accuracy and unprecedented in its power. Exploring key turning points in the development of investment theory, through the critical prism of award-winning investment theory and asset pricing expert Mark Rubinstein, this groundbreaking resource follows the chronological development of investment theory over centuries, exploring the inner workings of great theoretical breakthroughs while pointing out contributions made by often unsung contributors to some of investment's most influential ideas and models.

Leseprobe

Contents

Preface

The Ancient Period

Fibonacci Series, Present Value, Partnerships, Finite-Lived Annuities, Capital Budgeting

Problem of Points, Accounting, Debits vs. Credits, Accounting Identity, Assets, Liabilities, and Equities, Clean-Surplus Relation, Book vs. Market Values, Matching Principle, Consistency Principle

Pascal’s Triangle, Probability Theory, Problem of Points, Binomial Categorization, Expectation, Counting Paths vs. Working Backwards, Path Dependence, Pascal’s Wager

Probability Theory, Expectation, Arbitrage, State-Prices, Gambler’s Ruin Problem

Statistics, Mortality Tables, Expected Lifetime

Life Annuities, Present Value, Mortality Tables, State-Prices, Tontines

Risk Aversion, St. Petersburg Paradox, Expected Utility, Logarithmic Utility, Diversification, Weber-Fechner Law of Psychophysics, Bounded Utility Functions

Ordinal vs. Cardinal Utility, Pareto Optimality, Optimality of Competitive Equilibrium

Average or Representative Man, Normal Distribution, Probability in The Social Sciences

Brownian Motion, Option Pricing, Random Walk, Normal Distribution

Risk vs. Uncertainty, Source of Business Profit, Diversification

Spot vs. Forward Prices, Forward vs. Expected Prices, Normal Backwardation, Convenience Yield, Hedging vs. Speculation

Intertemporal Consumption, Production, and Exchange, Rate of Interest, Fisher Effect, Impatience vs. Opportunity, Fisher Separation Theorem, Competitive Markets, Unanimity vs. Pareto Optimality, Real Options, Speculation, Capital Budgeting

Exhaustible Resources, Hotelling’s Rule, Extraction As An Option, Gold

Investment Performance, Efficient Markets

Security Analysis, Fundamental Analysis, Capital Structure, Growth vs. Value, Rebalancing, Dollar-Cost Averaging, Efficient Markets, Mathematical Finance, Extremes of Investment Performance

Market Rationality, Market Psychology, Markets vs. Beauty Contests vs. Casinos, Risk vs. Uncertainty, Liquidity Preference

Present Value, Dividend Discount Model, Perpetual Dividend Growth Formula, Arbitrage, Discounting Earnings vs. Dividends, Value Additivity, Iterated Present Value, Capital Structure, Law of The Conservation of Investment Value, Law of Large Numbers, Marginal Investor

Duration, Four Properties of Duration, Parallel Shift in Interest Rates, Arbitrage

Aggregation of Information, Price System, Efficient Markets, Socialism vs. Capitalism

Expected Utility, Independence Axiom, Subjective vs. Objective Probability, Allais Paradox, Experimental Measurement of Utility

Risk Aversion and Gambling, Lotteries, Reference-Dependent Utility, Prospect Theory, Dynamic Strategies

Random Walk, Martingales, Efficient Markets

The Classical Period

Volatility

Diversification, Portfolio Selection, Mean-Variance Analysis, Covariance, Risk Aversion, Law of Large Numbers, Efficient Set, Critical Line Algorithm, Long-Term Investment, Semivariance, Market Model

State-Securities, Complete Markets, State-Prices, Market-Equivalence Theorem, Dynamic Completeness, Portfolio Revision, Moral Hazard, Risk-Neutral vs. Subjective Probability, Sequential Markets, Existence and Optimality of Competitive Equilibrium

Random Walk, Normal Distribution, Efficient Markets

Assumptions vs. Conclusions, Darwinian Survival, Arbitrage

Riskless Security, Mean-Variance Preferences, Tobin Separation Theorem, Quadratic Utility, Multivariate Normality

Law of The Conservation of Investment Value, Capital Structure, Modiglianlmiller Theorem, Dominance vs. Arbitrage, Short Sales, Weighted Average Cost of Capital, Value Additivity, Value vs. Stock Price Irrelevancy

Existence and Optimality of Competitive Equilibrium

Brownian Motion, Random Walk, Weber-Fechner Law of Psychophysics, Lognormal Distribution

Individual Observations vs. Averages, Spurious Correlation, Index Construction and Stale Prices

Coase Theorem, Property Rights, Modigliani-Miller Theorem

Random Walk, Filter Rules, Efficient Markets

Rational Expectations, Aggregation Of Information

Dividend Policy, Earnings Growth and Share Prices, Discounting Earnings vs. Dividends, Investment Opportunities Approach

Risk vs. Uncertainty, Ellsberg Paradox, Independence Axiom, Subjective Probability

Long-Run Investment, Logarithmic Utility, Rebalancing, Darwinian Survival

Stochastic Dominance, Increasing Risk

Intertemporal Consumption and Investment, Time-Additive Utility, Logarithmic Utility, Uncertain Lifetime, Life Insurance

Portfolio Selection, Mean-Variance Analysis, Market Model, Residual vs. Systematic Risk, Multifactor Models, Style Factor Portfolios

Time-Diversification, Risk Aversion and Gambling, Law of Large Numbers, Probabilistic Preferences

Holding-Period Return, Equity Risk Premium Puzzle

Risk Aversion, Absolute Risk Aversion, Relative Risk Aversion, Favorable Gambles Theorem

Capital Asset Pricing Model (CAPM), Mean-Variance Analysis, Market Portfolio, Beta, Risk Premium, Systematic Risk, Joint Normality Co Variance Theorem, Tobin Separation Theorem, Homogeneous Beliefs

Random Walk, Lognormal Distribution, Fat Tails, Stable-Paretian Hypothesis, Runs Tests, Filter Rules, Efficient Markets, Weekend vs. Trading Day Variance, Mutual Fund Performance

Capital Asset Pricing Model (CAPM), Riskless Return, Beta

Capital Asset Pricing Model (CAPM), Mutual Fund Performance, Sharpe Ratio, Market Timing vs. Security Selection

Multifactor Models, Industry Factors, Sector Factors, Cluster Analysis

Individual Investor Performance

Stable-Paretian Hypothesis, Volatility, Nonstationary Variance, Stochastic Volatility, Fat Tails, Excess Kurtosis, Autoregressive Conditional Heteroscedasticity (ARCH)

Aggregation, Pareto-Optimal Sharing Rules, Consensus Investor, Exponential Utility

Multiperiod Portfolio Selection, Long-Term Investment, Portfolio Revision, Myopia, Working Backwards, Dynamic Programming, Indirect or Derived Utility, Time-Additive Utility, Constant Absolute Risk Aversion (CARA), Hyperbolic Absolute Risk Aversion (HARA), Logarithmic Utility, Power Utility, Turnpikes

Mutual Fund Performance, Alpha, Beta, Market Model, Luck vs. Skill

Uncertain Endowed Income, Substitution vs. Income Effects, Precautionary Savings, Absolute Risk Aversion

Event Studies, Stock Splits, Earnings Announcements, Market Model, World Events, Accounting Changes, Block Trading, Second-Hand Information

State-Dependent Utility, Intertemporal Consumption and Investment, Working Backwards, Implied Or Derived Utility, Risk Aversion

Efficient Markets, Random Walk, Weak vs. Semistrong vs. Strong Form Efficiency, Fully Reflect Information, Minimally vs. Maximally Rational Markets, Properly Anticipated Prices, Martingales, Earnings Announcements

Hyperbolic Absolute Risk Aversion (HARA), Portfolio Separation, Quadratic Utility, Constant Relative Risk Aversion (CRRA), Normal Distribution

Adverse Selection, Asymmetric Information, Rational Expectations

Accounting Beta, Financial Leverage, Operating Leverage

Intertemporal Consumption and Investment, HARA, CRRA, CARA, Continuous-Time, Continuous-State Capm, Intertemporal Asset Pricing, Stochastic Calculus, State-Dependent Utility, Stochastic Opportunity Set

Term Structure of Interest Rates, Irreversibility

Capital Asset Pricing Model (CAPM), Grouping Data, Alpha, Beta, Zero-Beta CAPM

Zero-Beta CAPM, Portfolio Separation, Joint Normality Co Variance Theorem, Aggregate Risk Aversion, Skewness Preference CAPM, Coskewness

Portfolio Selection, Capital Asset Pricing Model (CAPM), Market Model, Portfolio Separation, Market Portfolio, Riskless Security, Alpha, Beta, Residual vs. Systematic Risk, Market Timing vs. Security Selection, Short Sales

Derivatives, Options, Arbitrage, Put-Call Parity Relation, European vs. American Options, Payout Protection, Option Early Exercise

Size Effect, Beta, Price Effect, Market-To-Book Anomaly

Derivatives, Options, Option Pricing, Black-Scholes Formula, Lognormal Distribution, Volatility, Dynamic Strategies, Self-Financing Strategies, Arbitrage, Portfolio Revision, Replicating Portfolio, Dynamic Completeness, Down-and-Out Options, Hedge Relation, Bull Spread Relation, Butterfly Spread Relation, Time Spread Relation, Payoff Function, Implied Volatility, Corporate Securities as Options, Default Option, State-Prices

Efficient Markets, Random Walk, Martingales, Risk Aversion, Constant Relative Risk Aversion (CRRA)

Dividends, Priced vs. Nonpriced Factors

Aggregation, Heterogeneous Beliefs, Market-Equivalence Theorem, Portfolio Separation, State-Securities, Consensus vs. Composite Investor, Logarithmic Utility, Average or Representative Man

Diversification, Risk Aversion, Capital Asset Pricing Model (CAPM)

Fisher Effect, Nominal vs. Real Interest Rate, Inflation, Stock Prices and Inflation

Efficient Markets, Fully Reflect Information, no Trade Theorems, State-Securities, Consensus Beliefs, Pareto Optimality

Logarithmic Utility, Logarithmic Utility CAPM, Aggregation, Heterogeneous Beliefs, Consensus Beliefs, Limited Liability, Default-Free Annuity, Intertemporal Portfolio Separation

Volatility, Stochastic Volatility, Compound Options, Constant Elasticity Of Variance (CEV) Diffusion Model, Financial Leverage, Operating Diversification, Myopia, Continuous-Time Continuous-State CAPM

Portfolio Separation, Stationarity

Crra Intertemporal Capm, Pricing Uncertain Income Streams, Single-Price Law of Markets, Arbitrage, State-Prices, Consumption-Based CAPM, Local Expectations Hypothesis, Unbiased Term Structure, Random Walk, Option Pricing, Time-Additive Utility, Logarithmic Utility, Black-Scholes Formula, Equity Risk Premium Puzzle, Joint Normality Covariance Theorem

Efficient Markets, Rational Expectations, Aggregation Of Information, Exponential Utility, Consensus Beliefs, Darwinian Survival

Arbitrage Pricing Theory (APT), Diversification, Law of Large Numbers, Multifactor Models, APT vs. CAPM, Portfolio Separation, Priced vs. Nonpriced Factors, Market Portfolio

Capital Asset Pricing Model (CAPM), Mean-Variance Efficiency, Market Portfolio

Closed-End Fund Discounts, Closed-End vs. Open-End Funds, Efficient Markets

Fundamental Theorem, Single-Price Law of Markets, Arbitrage, State-Prices, Complete Markets, Capital Asset Pricing Model (CAPM), Black-Scholes Formula, Perfect Markets, Value Additivity

Short Sales, Heterogeneous Beliefs, Portfolio Separation, Favorable Gambles Theorem, Aggregation of Information

Options, Complete Markets, Portfolio Separation, Market Portfolio, Heterogeneous Beliefs, Market-Equivalence Theorem

Market Segmentation, Nonmarketable Assets, Capital Asset Pricing Model (CAPM), Neglected Stocks

Option Pricing, State-Prices, Butterfly Spreads, Lognormal Distribution, Black-Scholes Formula, Crraintertemporal CAPM

Efficient Markets

Option Pricing, Binomial Option Pricing Model, Black-Scholes Formula, Recombining Binomial Trees, Working Backwards, Option Early Exercise

Intertemporal Consumption and Investment, Consumption-Based CAPM, Continuous-Time, Continuous-State CAPM, Consumption Beta, Market Portfolio, Lognormal Distribution, Stochastic Opportunity Set

The Modern Period

Market Portfolio, Dynamic Strategies, Path Dependence

Market Efficiency, Rational Expectations, Aggregation of Information, Partially vs. Fully Revealing Rational Expectations Equilibria, Informed vs. Uninformed Traders, Overconfidence, Hyperefficient Markets

Expected Returns, Random Walk, Market Portfolio, Equity Risk Premium, Sample vs. Population Statistics, Jump or Poisson Process

Investment Performance, Market Timing, Luck vs. Skill

Efficient Markets, Weekend vs. Trading Day Variance, Excess Volatility

Equity Risk Premium Puzzle, Crraintertemporal CAPM, Time-Additive Volatility, Habit Formation, Volatility, Excess Volatility, Risk Aversion

Short Sales, Heterogeneous Beliefs, Stock Market Crashes, Aggregation of Information, Rational Expectations, Skewness, Put-Call Parity Relation, Bubbles

Derivatives, Options, Option Pricing, Binomial Option Pricing Model, Implied Binomial Trees, Recombining Binomial Trees, Working Backwards, State-Prices, Stochastic Volatility

Dividends, Earnings, Dividend Discount Model, Clean-Surplus Relation, Abnormal Earnings Discount Model, Investment Opportunities Approach, Economic Value Added (EVA)

Size Effect, Priced vs. Nonpriced Factors

Average Or Representative Man, Aggregation, Cautiousness, Constant Relative Risk Aversion (CRRA)

Mutual Fund Performance, Persistence, Three- vs. Four-Factor Model, Alpha, Momentum, Luck vs. Skill

Real Options, Capital Budgeting, Time-Varying Expected Returns

Preference Uncertainty, Learning, Complete Markets, Aggregation

Bubbles, Stock Market Crashes, Informed vs. Uninformed Traders, Separation of Probabilities and Preferences, Felicity

Index of Ideas

Index of Sources

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Copyright © 2006 by Mark Rubinstein. All rights reserved.

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Library of Congress Cataloging-in-Publication Data:

Rubinstein, Mark, 1944–

A history of the theory of investments : my annotated bibliography / Mark Rubinstein.

p. cm.—(Wiley finance series) Includes index.

ISBN-13 978-0-471-77056-5 (cloth)

ISBN-10 0-471-77056-6 (cloth)

1. Investments. 2. Investments—Mathematical models. 3. Investments—Mathematical models—Abstracts. I. Title. II. Series.

HG4515.R82 2006

016.3326'01—dc22

2005023555

To celebrate the memory and glory

of the ideas of financial economics

Preface

Ideas are seldom born clothed, but are gradually dressed in an arduous process of accretion. In arriving at a deep knowledge of the state of the art in many fields, it seems necessary to appreciate how ideas have evolved: How do ideas originate? How do they mature? How does one idea give birth to another? How does the intellectual environment fertilize the growth of ideas? Why was there once confusion about ideas that now seem obvious?

Such an understanding has a special significance in the social sciences. In the humanities, there is little sense of chronological progress. For example, who would argue that in the past three centuries English poetry or drama has been written that surpasses the works of Shakespeare? In the natural sciences, knowledge accumulates by uncovering preexisting and permanent natural processes. Knowledge in the social sciences, however, can affect the social evolution that follows discovery, which through reciprocal causation largely determines the succeeding social theory.

In this spirit, I present a chronological, annotated bibliography of the financial theory of investments. It is not, however, a history of the practice of investing, and only occasionally refers to the real world outside of theoretical finance. To embed this “history of the theory of investments” in a broader context that includes the development of methodological and theoretical tools used to create this theory, including economics, mathematics, psychology, and the scientific method, I am writing companion volumes—a multiyear project—titled My Outline of Western Intellectual History, which also serves to carry this history back to ancient times.

Although this work can be used as a reference, to read it as a history one can read from the beginning to the end. For the most part, papers and books are not grouped by topic since I have tried to see the field as an integrated whole, and to emphasize how one strand of research impacts others that may initially have been thought to be quite separate. For this purpose a chronological ordering—though not slavishly adhered to—seems appropriate since a later idea cannot have influenced an earlier idea, only vice versa.

If I may indulge in the favorite pastime of historians, one can divide the history of financial economics into three periods: (1) the Ancient Period before 1950, (2) the Classical Period from about 1950 to 1980, and (3) the Modern Period post-1980. Since about 1980, the foundations laid down during the Classical Period have come under increasing strain, and as this is written in 2005, it remains to be seen whether a new paradigm will emerge.

Of necessity, I have selected only a small portion of the full body of financial research that is available. Some papers are significant because they plant a seed, ask what turns out to be the right question, or develop important economic intuitions; others are extraordinarily effective in communicating ideas; yet others are important because they formalize earlier concepts, making all assumptions clear and proving results with mathematical rigor. Although I have tried to strike some balance between these three types of research, I have given more prominence to the first two. Unpublished working papers are included only if they either (1) are very widely cited or (2) appear many years before their ideas were published in papers by other authors. A few literature surveys are mentioned if they are particularly helpful in interpreting the primary sources. Mathematical statements or proofs of important and condensable results are also provided, usually set off by boxes, primarily to compensate for the ambiguity of words. However, the proofs are seldom necessary for an intuitive understanding.

The reader should also understand that this book, such as it is, is very much work in progress. Many important works are not mentioned, not because I don’t think they are important, but simply because I just haven’t gotten to them yet. So this history, even from my narrow vantage point, is quite partial and incomplete, and is very spotty after about 1980. In particular, though it traces intimations of nonrationalist ideas in both the ancient and classical periods, it contains very little of the newer results accumulating in the modern period that have come under the heading of “behavioral finance.” Nonetheless, the publisher encouraged me to publish whatever I have since it was felt that even in such a raw form this work would prove useful. Hopefully, in the fullness of time, an updated version will appear making up this deficit.

The history of the theory of investments is studded with the works of famous economists. Twentieth-century economists such as Frank Knight, Irving Fisher, John Maynard Keynes, Friedrich Hayek, Kenneth Arrow, Paul Samuelson, Milton Friedman, Franco Modigliani, Jack Hirshleifer, James Tobin, Joseph Stiglitz, Robert Lucas, Daniel Kahneman, Amos Tver-sky, and George Akerlof have all left their imprint. Contributions to finance by significant noneconomists in this century include those by John von Neumann, Leonard Savage, John Nash, and Maurice Kendall. Looking back further, while the contributions of Daniel Bernoulli and Louis Bachelier are well known, much less understood but of comparable importance are works of Fibonacci, Blaise Pascal, Pierre de Fermat, Christiaan Huygens, Abraham de Moivre, and Edmund Halley.

Perhaps this field is like others, but I am nonetheless dismayed to see how little care is taken by many scholars to attribute ideas to their original sources. Academic articles and books, even many of those that purport to be historical surveys, occasionally of necessity but often out of ignorance oversimplify the sequence of contributors to a finally fully developed theory, attributing too much originality to too few scholars. No doubt that has inadvertently occurred in this work as well, but hopefully to a much lesser extent than earlier attempts. Even worse, an important work can lie buried in the forgotten past; occasionally, that work is even superior in some way to the later papers that are typically referenced.

For example, ask yourself who first discovered the following ideas:

Present value.

The Modigliani-Miller theorem.

Pratt-Arrow measures of risk aversion.

Markowitz mean-variance portfolio theory.

The Gordon growth formula.

The capital asset pricing model.

The Black zero-beta model.

The Cox-Ross-Rubinstein binomial option pricing model.

The Lucas exchange model.

The Milgrom-Stokey no trade theorem.

The derivation of expected utility from postulates of individual rationality.

The martingale pricing representation with risk-neutral probabilities.

Dynamic completeness.

The association of random walks with rational markets.

The use of nonstationary variance to describe the stochastic process of security prices.

The hypothesized relationship between upwardly biased stock prices, belief heterogeneity, and short-selling constraints.

The size effect.

The abnormal earnings growth model.

Prospect theory.

In most of these cases, the individuals commonly given bibliographical credit in academic papers were actually anticipated many years, occasionally decades or centuries, earlier. In some cases, there were others with independent and near-simultaneous discoveries who are seldom, if ever, mentioned, offering one of many proofs of Stephen Stigler’s law of eponymy that scientific ideas are never named after their original discoverer! This includes Stigler’s law itself, which was stated earlier by sociologist and philosopher of science Robert K. Merton. A prominent example in financial economics is the Modigliani-Miller theorem, which received possibly its most elegant exposition at its apparent inception in a single paragraph contained in a now rarely referenced but amazing book by John Burr Williams published in 1938, 20 years before Modigliani-Miller. Had his initial insight been well known and carefully considered, we might have been spared decades of confusion. A clear example of Merton’s naming paradox is the “Gordon growth formula.” Unfortunately, once this type of error takes hold, it is very difficult to shake loose. Indeed, the error becomes so ingrained that even prominent publicity is unlikely to change old habits.

Also, researchers occasionally do not realize that an important fundamental aspect of a theory was discovered many years earlier. To take a prominent example, although the Black-Scholes option pricing model developed in the early 1970s is surely one of the great discoveries of financial economics, fundamentally it derives its force from the idea that it may be possible to make up for missing securities in the market by the ability to revise a portfolio of the few securities that do exist over time. Kenneth Arrow, 20 years earlier in 1953, was the first to give form to a very similar idea. In turn, shades of the famous correspondence between Blaise Pascal and Pierre de Fermat three centuries earlier can be found in Arrow’s idea. A field of science often progresses by drawing analogies from other fields or by borrowing methods, particularly mathematical tools, developed initially for another purpose. One of the delightful by-products of historical research is the connections that one often uncovers between apparently disparate and unrelated work—connections that may not have been consciously at work, but no doubt through undocumented byways must surely have exercised an influence.

One can speculate about how an academic field could so distort its own origins. Its history is largely rewritten, as it were, by the victors. New students too often rely on the version of scholarly history conveyed to them by their mentors, who themselves are too dependent on their mentors, and so forth. Seldom do students refuse to take existing citations at their word and instead dust off older books and journals that are gradually deteriorating on library shelves to check the true etiology of the ideas they are using. Scholars have the all-too-human tendency of biasing their attributions in the direction of those whom they know relatively well or those who have written several papers and spent years developing an idea, to the disadvantage of older and more original works by people who are not in the mainstream, either in their approach to the subject, by geography, or by timing. An excellent example of this is the sole paper on mean-variance portfolio selection by A.D. Roy, whom Harry Markowitz acknowledges deserves to share equal honor with himself as the co-father of portfolio theory.1 Robert K. Merton has dubbed this the “Matthew effect” (particularly apt since it may serve as an example of itself) after the lines in the Gospel According to Matthew (25:29): “Unto everyone that hath shall be given, and he shall have abundance; but from him that hath not shall be taken away even that which he hath.”

Of course, financial economics is not alone in its tendency to oversimplify its origins. For example, consider the calculus, well known to have been invented by Isaac Newton and Gottfried Wilhelm Leibniz. Yet the invention of calculus can be traced back to the classical Greeks, in particular Antiphon, Eudoxus, and Archimedes, who anticipated the concept of limits and of integration in their use of the “method of exhaustion” to determine the area and volume of geometric objects (for example, to estimate the area of a circle, inscribe a regular polygon in the circle; as the number of sides of the polygon goes to infinity, the polygon provides an increasingly more accurate approximation of the area of the circle). Although Galileo Galilei did not write in algebraic formulas, his work on motion implies that velocity is the first derivative of distance with respect to time, and acceleration is the second derivative of distance with respect to time. Pierre de Fermat devised the method of tangents that in substance we use today to determine the maxima and minima of functions. Isaac Barrow used the notion of differential to find the tangent to a curve and described theorems for the differentiation of the product and quotient of two functions, the differentiation of powers of x, the change of variable in a definite integral, and the differentiation of implicit functions.

Unlike large swaths of history in general, much of the forgotten truth about the origins of ideas in financial economics is there for all to see, in older books residing on library shelves or in past journals now often available in electronic form. Much of the history of investments has only been rewritten by the victors, and can be corrected from primary sources. In this book, I have tried my best to do this. For each paper or book cited, my goal is to clarify its marginal contribution to the field.

Like the three witches in Shakespeare’s Macbeth (and I hope the resemblance ends there), with hindsight, I can “look into the seeds of time, and say which grain will grow and which will not.” Taking advantage of this, I will deemphasize research (such as the stable-Paretian hypothesis for stock prices) that, although once thought quite promising, ultimately proved to be a false path.

Nonetheless, I am certain that I also have omitted many important discoveries (in part because I just haven’t gotten to them) or even attributed ideas to the wrong sources, unaware of even earlier work. Perhaps, on the other hand, I have succumbed to the historian’s temptation to bias his interpretation of the written record in light of what subsequently is seen to be important or correct. I hope the reader will forgive me. I have already received some assistance from Morton Davis, and I wish to publicly thank him. I also ask the reader to take the constructive step of letting me know these errors so that future revisions of this history will not repeat them.

Mark Rubinstein

Berkeley, California

January 2006

1. Too recently discovered to be included in this history is a 1940 paper of the Italian mathematician Bruno de Finetti, predating Markowitz and Roy by 12 years, which formulates mean-variance portfolio theory, including a justification for measuring risk by portfolio variance, the equation relating the covariances of security returns to the portfolio variance of return, mean-variance efficient sets, and a critical line algorithm to numerically solve the portfolio selection problem. Although de Finetti’s paper formulates the general quadratic programming problem including short-sale constraints for the general case, only an algorithm for solving it in the special case of uncorrelated returns is fully worked out. Written in Italian, the paper has remained unknown among financial economists until it was just recently brought to my attention and translated into English.