Bernstein’s Capital Ideas

I used to blog more on personal finance. That’s because it used to occupy more of my interest. Once I got my finances in order and made big decisions about how to save for retirement and kids’ college expenses, how much life insurance to buy, and so forth, there was less to think and write about. Being a Boglehead-style, buy-and-hold, index fund type investor, I don’t need to pay much attention to my portfolio or the markets. An hour or two a few times a year is more than enough and hardly fodder for blogging.

I lost interest in personal finance books too, having read many, including a shelf of textbooks included in Certified Financial Planning curricula. If one is interested in the Boglehead approach, there is really no need to read more than a few books (see my comments on the Bogleheads’ Guide books).

But I heard that Perter Bernstein’s books were different. Less about investing guidance and more about the history of finance, markets, and the theoretical and academic underpinnings of them, they promised a different view of the subject. I’ve just completed his Capital Ideas: The Improbable Origins of Modern Wall Street, and it lived up to that promise. A review at sums it up well.

The book traces the development of Modern Finance Theory, from the first recorded attempt at developing a mathematical theory to explain stock prices (Louis Bachelier’s dissertation entitled “Theory of Speculation” in 1900), to the work of the Cowles Foundation in the 1930s, and, of course, Harry Markowitz’s famous 1952 short paper titled “Portfolio Selection” – all the way to more modern theorists and practitioners, such as Paul Samuelson, Bill Sharpe, Fischer Black, Myron Scholes, Robert Merton … and Franco Modigliani and Merton Miller. Mr. Bernstein weaves his discussions together in one, neat timeline, interspersed with many fascinating stories along the way.

What fascinates me may not fascinate another (and vice versa). But trust me, if you’ve got any interest in finance theory and the history of markets, you’ll be intrigued by something in Bernstein’s telling of the story. One example of something I learned: I had not been aware of the role of portfolio insurance in the October 1987 stock market crash (nor the development of the ideas that contributed to portfolio insurance itself). Actually, there’s some controversy over the extent of that role, which Bernstein explains.

I also found interesting that Markowitz published a 1956 paper in National Research Logistics Quarterly titled “The Optimization of a Quadratic Function Subject to Linear Constraints.” Such an optimization problem is at the heart of the approach I took in my Master’s Thesis and a published paper in which I developed a computationally efficient technique for locating an anomalous region in an image formed from tomographic measurements. (I’d love to read that paper by Markowitz, but I can’t find it online.)

Bernstein has written several other books on the history of finance, some of which I purchased in a boxed set. They’re on my stack. Once I read them, I’ll post my thoughts.

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