This book is the fourth in a series of discussions about the great minds in the history and theory of finance. While the other volumes treat the life cyclists who described our investment paths over a lifetime, the portfolio theorists who demonstrate how an equilibrium market portfolio is optimally derived, and the rise of the quants that derived how securities are priced, this volume on the efficient market hypothesists describes the prevailing equilibrium paradigm in modern finance theory. These efficient market hypothesists assert that the forces of arbitrage provide pricing discipline for financial markets. The great minds that have contributed to or critiqued such an approach to financial market equilibrium have fomented discussion within financial circles that is unparalleled, in conceptual usefulness, in controversy, and in influencing how even the lay investor views financial markets. We explore the meaning of the efficient market hypothesis from the perspective of six great minds. We begin with the work of the obscure mathematical physicist Louis Bachelier who described the random walk and derived an early version of the options pricing formula more than a century ago. We then describe the life work and contributions to finance of Paul Samuelson, one of the greatest proponents of mathematically rigorous analysis and the concept of arbitrage in finance. We then turn to Eugene Fama, the great mind most associated with the efficient market hypothesis, a term he coined and we have used ever since. We then look at the work of three great minds who each worked on variations or critiques of the efficient market hypothesis. Stephen Ross provided us with his arbitrage pricing theory. Nobel Prize winner James Tobin critiqued the efficient market hypothesis, and Robert Shiller demonstrated that markets may exhibit irrational exuberance, at odds with the hypothesis' predictions. These great minds and their provocative theories offer us an opportunity to resolve, or at least discuss, the following questions. Do financial securities follow a random walk? Does arbitrage allow markets to digest and fully incorporate all available information into the price of securities? Do the assumptions of the efficient market hypothesis make intuitive sense? If not, how can we further refine our understanding of the behavior of financial markets? We answer these questions through the context of the lives of six great minds in finance. Their lives informed their research, and their research in turn informed our understanding of the very nature of financial markets. Because of their insights, we have forever changed the way we look at markets. That is the mark of genius.
Preface to the Great Minds in Finance Series Preamble Introduction PART I: LOUIS BACHELIER - THE FIRST PHYSICIST FINANCIAL THEORIST Louis Bachelier - The Early Years The Times The Theory Discussion and Applications - Einstein and Bachelier Life and Legacy PART II: PAUL SAMUELSON'S RANDOM WALK Paul Samuelson - The Early Years The Times The Theory Discussion and Applications The Nobel Prize, Life and Legacy PART III: EUGENE FAMA'S EFFICIENT MARKET HYPOTHESIS Eugene Fama - The Early Years The Times The Theory Discussion and Applications Career and Legacy PART IV: STEPHEN ROSS AND ARBITRAGE PRICING THEORY Stephen Alan Ross - the Early Years The Times The Theory Discussion and Applications Career and Legacy PART V: JAMES TOBIN AND A NEW POLICY James Tobin - The Early Years The Times The Theory Discussion and Applications The Nobel Prize, Life, and Legacy PART VI: ROBERT SCHILLER AND IRRATIONAL EXUBERANCE Robert Shiller - The Early Years The Times The Theory Discussion and Applications Career and Legacy PART VII: WHAT WE HAVE LEARNED Combined Contributions Conclusions Glossary Index Endnotes