The (Very) Early History of Financial Economics

12 August 2010 at 11:45 am Peter G. Klein 1 comment

| Peter Klein |

The latest issue of the History of Economics Review contains Geoffrey Poitras and Jovanovic’s interesting paper, “Pioneers of Financial Economics: Das Adam Smith Irrelevanzproblem?” (published version not available online; working-paper version here, presentation slides here). Despite the subtitle the paper isn’t about Adam Smith, but the (very) early history of financial economics. Here’s an excerpt:

In the case of financial economics, the roots of this field stretch back to antiquity, involving the valuation of financial transactions, such as determining payment on a loan or distributing profits from a partnership. Poitras (2000) uses the late fifteenth century as a starting point for the early or pre-classical history of financial economics, more than three centuries prior to the publication of the [Wealth of Nations]. As early as Fibonacci (1170?-1250?), elements of financial economics were being disseminated among the merchant classes in the commercial arithmetics that, by the fifteenth century, formed the core of the reckoning school curriculum, e.g., Swetz (1987). A fundamental historical demarcation point appears with Christian Huygens’s (1629-1695) seminal introduction of the modern theory of expectations.

From this point, until the appearance of the WN, the founding work of classical political economy, financial economics underwent a dramatic transformation. By the time the Theory of Moral Sentiments appeared, sophisticated methods for pricing contingent claims, such as the life annuities sold by various individuals, municipalities and national governments in western Europe, had been developed and were being applied to the establishment of actuarially sound life insurance plans and pension funds. Hald (1990), Poitras (2006), Lewin (2003) and Rubinstein (2003) among others identify the earliest pioneers of modern financial economics, the beginning of classical financial economics, from the contributors that developed these pricing methods. As such, there is a close connection between the classical histories of financial economics, statistics, and actuarial science.

In other words, this is a field in which theory and practice appear to have co-evolved quite closely, which raises interesting questions for the performativity crowd. Modern financial economics is in many ways similar: theories of market efficiency were both shaped by, and helped to shape (e.g., through options-pricing formulas) actual market behavior.