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Hetp/2-2018: 75-93 Essays
Finance, a New Old Science
Maria Eugénia Mata, José Rodrigues da Costa and David Justino*
Introduction
Dealing with important issues that are related to wealth and revenue, corporate
nancial literacy and knowledge may determine an individual’s success in life,
or even their survival in old age. Finance is usually considered to be a complex
science among common people, often driven by the perception that it consists
of unsatisfactory explanations of the mystery and volatility of nancial markets.
Corporate Finance is a scientic eld today, as the need to understand nancial
markets is widespread, and receives a great deal of attention. All over the world
Finance has carved out a large space in schools of Economics and Management
in recent decades. Specialized departments of Finance in most Economics and
Management schools have developed extensive scientic knowledge on nancial
markets. Professors of Finance and scholarly journals in the eld offer consider-
able scientic advances, and nancial markets’ sophistication benet from ever
greater nancial literacy.
The history of Corporate Financial Thought is also a well cultivated eld to-
day, led by experts who have made great efforts to identify its main contributors
(Miller, 1999: 95). The 1950s have been identied by many as the breakthrough
moment for the birth of the science of Finance. Motivating this paper is the aim
of recalling contributors from the late 1800s and the early 1900s, before the First
World War, as major cases of literacy and erudition in Finance, who provided
much literature in this eld.
* Maria Eugénia Mata, Associate Professor, Faculdade de Economia, Campus de Campolide,
Lisboa, http://docentes.fe.unl.pt/~memata/; memata@fe.unl.pt; José Rodrigues da Costa, MBA
Invited Professor Instituto Superior de Ciências do Trabalho e da Empresa, Lisbon, e-mail: jcosta@
euronext.com; David Justino, Professor, Faculdade de Ciências Sociais e Humanas, Lisbon, e-mail:
david.justino@fcsh.unl.pt. This paper belongs to the project PTDC/HIS-HIS/100132/2008 “The
Portuguese Capital Market during the 20th century and the Average Cost of Capital for Portuguese
Investments”, funded by the Portuguese Science Foundation. We thank Nova Forum for funding,
John Huffstot for correcting our English, our anonymous referees, and the editors.
76 M. E. Mata, J. Rodrigues da Costa, D. Justino/ Finance, a New Old Science
Section 1 and 2 will describe the sophisticated nancial culture of the early
twentieth century in Europe, revealing how accumulated expertise in domestic
production and trade, in international commercial links, insurance contracts,
currency transactions, share trading, bond issuance, and derivatives operations,
brought the pressing need for sophisticated nancial markets. The existence of
local, regional, and national Stock Exchanges were part of a world network of
nancial relationships in which London, Paris, Berlin, Vienna, Milan, Madrid,
Lisbon, and New York were the leading global markets (Cassis, 2006).1 Family
nancial culture and erudition in some social circles could stimulate a scien-
tic approach to nance, and mathematics were also applied to the concept of
stochastic processes, by Louis Bachelier (1900) in his doctoral dissertation The
Theory of Speculation, describing stock price evolution. Section 3 addresses the
issues that were current in textbooks of the day, responding to the fact that local
and regional exchanges permitted improvement in the liquidity and visibility of
listed corporations’ share and bond issues, also promoting reduced transaction
fees. The nal section concludes.
1. Late nineteenth-century globalization and nancial markets
Investment strategy to manage diversied portfolios is an intimidating concept
for most people even today, but a vast nancial elite operating businesses in the
late nineteenth century developed practical expertise in portfolios management
(Jones 1994). With operations that underpinned the urban centres and their role
in the broad networking system of information, expectations, investment, and
transactions, they belonged to wealthy social circles (Foreman-Peck 2011a).
Industrialization in the British Isles and on the European Continent had brought
large corporations to the fore of economic activity, having large volumes of com-
modities to consume, sell, and export, while a number of spot and term (deriva-
tives) contracts were established amongst distant economic agents (Hertner and
Jones, 1986). Individual wealth could rarely supply enough capital for such large
businesses, but nancial institutions could provide a mechanism for gathering
capital and rewarding private savings, whatever the amount to be made available
and involved in those businesses (Cassis, 1997). Banks and Stock Exchanges,
gathering the available savings, helped to channel them to useful nancial ap-
plications, providing attractive rewards to capital owners who were interested in
their services (Bordo et al. 2003). Shareholding positions in corporations could
provide good rewards to (small) private investors. Safety, condence, and low
information costs were top values to fuel this mechanism of transforming savings
into investment (Jones, 1996). Information costs had decreased dramatically.
Not only were transports and posts working efciently thanks to railroads
and sail and steam shipping, but also telegraphs were installed. The press pro-
1 Sylla et al. 2009.
History of Economic Thought and Policy/2-2018 77
vided daily information on Stock Exchange transactions and asset quotations.
Transparency was considered an essential feature for advertising stocks. Stock
Exchanges published daily bulletins containing information about the listed
issues, bids and ask offers, and prices of the transactions executed. Specialized
newspapers devoted attention to corporations operating on all continents, even
in the most remote regions of the world. Capital gains and dividend pay-outs
were announced worldwide (O’Rourke; Williamson 1999). The telegraph was a
powerful instrument in decreasing information costs, and a world network was
made available thanks to submarine cable technology. Wireless radio telegraphy
using Hertzian waves and Morse Code was also beginning to have a role in the
Belle Epoque (Love 2012). Throughout the last decades of the century all Stock
Exchanges were in touch with each other, and telephones also began to offer yet
another information network (Foreman-Peck 2001a).
Dealers, accountants, brokers, bankers, and nance experts in general formed
a technical staff that operated according to behavioural rules derived from codes
of honour intended to inspire condence, transparency, and trust. Foreign and
domestic Treasury Bonds, as well as corporation shares and debentures were
very attractive. Because of superior European technology this period led to the
exploitation of business opportunities on all other continents (Jones, 2010).
Mining (including precious metals), agribusiness, railroad building, shipping,
banking, and insurance, as well as trading and commerce in general were trans-
ferred from the European business environment to all other endeavours (Jones
2005). European investment and capital moved to North, Central, and South
America, as well as to Asia and Africa (especially after the Berlin Conference of
the late 1880s). In most cases, emigration accompanied the transfer of savings
and other ows of capital, leading to a universal spread of European economic
culture and international nancial expertise.
Thanks to the gold-standard regime, the monetary context was favourable to
international business, foreign direct investment (FDI), and nancial connections.
Free capital movements, including repatriation of prots and dividends, and xed
exchange rates provided an excellent business background, minimizing transfer
risk because of minimizing exchange-rate volatility to the gold-entrance and
gold-exit points that arbitrage could manage (Ofcer 1989). This nancial system
broke up in August 1914, when the Austrian empire declared war on Serbia, and
many other European nations decided to support one side or the other in this
conict, although Spain, Switzerland, the Netherlands, Denmark, Norway, and
Sweden remained neutral (Hardach 1987). Nevertheless, before 1914 a Euro-
pean nancial civilization circled the planet, from the UK to Southern Europe,
Canada, and the USA, from Germany to Eastern European regions and Russia,
from continental European countries to Malaysia and the Philippines, and even
from the UK and Belgium to Portugal, Angola, and Mozambique (Foreman-Peck,
2001b). As John M. Keynes (1924: 11) says:
What an extraordinary episode in the economic progress of man that age was which
78 M. E. Mata, J. Rodrigues da Costa, D. Justino/ Finance, a New Old Science
came to an end in August 1914! […] The inhabitant of London could order by telephone,
sipping his morning tea in bed, the various products of the whole earth, in such quantity as
he might see t, and reasonably expect their early delivery upon his doorstep; he could at the
same moment and by the same means adventure his wealth in the natural resources and new
enterprises of any quarter of the world, and share, without exertion or even trouble, in their
prospective fruits and advantages; or he could decide to couple the security of his fortunes
with the good faith of the townspeople of any substantial municipality in any continent that
fancy or information might recommend.
Considerable expertise existed in creating management boards, writing stat-
utes (charters) for corporations, and listing issuers on Stock Exchanges. Law and
(commercial) codes were published in all European countries to regulate all of
the many activities and to avoid fraud and embezzlement. Legal environments
were carefully described in abundant literature devoted to the subject, and the
discussion of institutional frameworks was based on knowledge of current-day
operations for capital manipulation and nancial decision-making (Cagigal 2009).
Textbooks on law necessarily dealt with the legal aspects of Stock Exchanges,
including organizational details, rules for operations, and regulations for brokers’
activity (Cosack 1905; Vivante 1902; Franchi 1890; Marghieri 1886).
All countries had their Stock Exchanges located in the main urban centres.
The urban network was also a nancial network, made of one, two, or more
nancial poles for trading and nance. Youssef Cassis tells on the main capitals
of capital in Europe in his 2006 book with that very title (Capitals of Capital).
Local, regional, and national-level Stock Exchanges fuelled capital applications
and the nancial markets. Powerful families and social networks of well-known
persons directed these operations. Aristocrats, bankers, deputies, and other poli-
ticians, as well as successful traders inspired condence in investors and people
in general, by sitting on the boards of corporations and free-standing companies
(Wilkins and Schröter 1998).
Some authors also mention the Middle Age fairs as Exchanges to negotiate
internationally and operate money exchange rates, as issuing was a manorial
political privilege that resulted in a variety of circulating currencies.2 The ex-
pertise gained was business-instructive and cumulative, leading to a continuous
globalizing inuence of Europe on business venture, administration practice,
and capital raising systems (Rambaud 1884).
The institutional development of Stock Exchanges in Europe accompanied
the long-run historical needs of economic agents. In the Middle Age exchange
letters were transacted in Paris on a bridge, the Pont-au-Change, while Lisbon
pioneered international trade negotiations for commodity contracts and ship-
ping in the early sixteenth century as a result of the Discoveries (Neal 1990:
3; Justino 1994). Bruges is also recalled for its pioneering open-air business
2 Ulrich (1906: 94) identies 1304 as the origin of the Exchange in Paris, 1549 in Lyon, 1554 in
Toulouse, 1566 in Rouhen, 1571 in Bordeaux, and 1691 in Montpéllier.
History of Economic Thought and Policy/2-2018 79
and trade meetings circa 1580.3 Even so, before the First World War nancial
affairs belonged primarily to the London Stock Exchange, thanks to the British
hegemony over world markets. This fact was recognized in 1913, at Wall Street
(Antwerp 1913: 28):
Some day, no doubt, the United States will become a great creditor nation, as England
is, and then the eld of these operations will be extended to other countries. When that time
comes we shall take a hand, through the machinery of the Stock Exchange, in the development
of new and immense elds of human endeavour just as London does today.
Transactions moved from the Bank of England to the street Change-Alley,
with the rst building – Capel Court – made available only in 1802 (Duguid
1901: 4; Boudon 1898; Stringham 2002).
If the denition of a Stock Exchange includes the presence of corporations and
share trading, the large European trade companies become the historical bench-
mark to be considered (Poitras 2000; Neal 1990: 13, 131). The seventeenth-cen-
tury British, French, and Dutch East India Companies were top venture-capital
organizations for trade settlement connections with India, Indonesia, and other
Asian regions. Joseph de la Vega’s book Confusion de Confusiones, written in
1688, is a pioneering textbook on ethics for behaviour nance.4 In this work,
prudent advising, training in prot and loss forecasts, permanent management
of assets and patience are the main speculator’s rules, as revealed in a dialogue
between a philosopher, a merchant, and a shareholder. The book addresses the
operations of the Amsterdam Stock Exchange and stock markets in general. La
Vega’s book was “intended for the edication of the Jewish community of Am-
sterdam, largely Portuguese” (Neal, 1990: 16). The Amsterdam Stock Exchange
Association was a leading nancial centre in organizing and regulating share
trading in Northern continental Europe (Stringham 2003). Organizational aspects
led Paris to have two stock Exchanges in that city, the Parquet and the Coulisse.5
The Parquet was the regulated market organised by the Compagnie des Agents de Change
(CAC), the semi-private body of 60 ofcial brokers (agents de change) with a legal monopoly
on transactions. These brokers were recruited on strict social and wealth conditions which
provided high guarantees to the investors (…). By contrast, the Coulisse was a loosely or-
ganised market (with no juridical structure until 1884), illegal de jure but de facto tolerated
and even protected by the government. Its members (the coulissiers) acted both as brokers
and jobbers (Hautcoeur, Rezaee, and Riva 2010: 4).
The First World War interrupted all of this European prosperity. It brought a
3 In front of Van Den Bursen’s family house, the reason why Stock Exchanges became called
Bourses. Ulrich, 1906: 42.
4 Cardoso 2002. Grotius’ philosophy also had something to say about the ethics of nancial be-
haviour based on theories of private property rights, in the international society context.
5 The Exchange moved from Rue Quincapoix, to the Soissons palace, and to the Palais Brongniart.
Bedarride, 1901.
80 M. E. Mata, J. Rodrigues da Costa, D. Justino/ Finance, a New Old Science
bloody conict that lasted for four dramatic years, the consequences of which
changed the face of the world. The large empires’ traditional hegemony faced
newly industrialized allied countries. The extension of the conict along the
lengthy battle line, from Belgium to Southern Europe, paralyzed all normal
businesses (Hardach 1987). Priority was given to hostilities. Universities closed
for some periods of time, as did Stock Exchanges, and the conditions for glo-
balization were disrupted. Submarine warfare almost put an end to Atlantic
shipping (Rousseau and Sylla 2003). The gold-standard suddenly came to an
end, as military expenditure in all nations threw convertibility into disarray. The
conict exhausted all nations, all armies, and all families. So balanced were the
potential ghting forces on the two sides of the conict that it led to a stalemate.
The intervention of the United States tipped the balance. The sway of the Amer-
ican military forces reected the American economic superiority. By the end of
the conict, Europe was a continent in ruins. Fighting had ravaged not only the
battleelds but also national economies. Destruction, death, and annihilation
were the image of the face of Europe. Financial centres had ceased their function.
London, Paris, Frankfurt, and all the other Stock Exchanges had reduced their
volume of operations dramatically (Aldcroft 1987). The great nancial centre
was now New York, on the other side of the Atlantic (Michie 1987).
Such a devastating conict naturally brought difcult times for reconstruction
in the 1920s, a Great Depression in the ‘30s, and a Second World War from 1939
to 1945, which would wrack Europe again (Milward 1987). Demographic losses
only mirror the break in prosperity that the old continent had suffered for so long.
In such a context, the abundance of European nancial literature on Stock
Exchanges before 1914 gains a new rationality, as it corresponds to a European
civilizational heyday.
2. Finance, a new old Science
The European literature is replete with erudite descriptions of the Stock
Exchanges and stock markets, dealings with legal aspects, discussions of the
effects of regulations, and international comparisons of organizational features.
Most of the authors refer to medieval trade and 16th-18th centuries Expansion as
the origin for large trading expertise in commodities and the beginning for the
construction of trade houses.6
Many books are narratives of bubbles and follies, crises and losses, corporation
scandals, or on government corruption and low prices for bonds. They report on
the character of stock markets as agencies for clients and on Stock Exchange
operations (sight operations and term operations), and on natural disasters that
destroyed stock exchange houses, such as the great re in London (1660), or the
1755 earthquake in Lisbon. Some tell on the presence of Jews in stock markets,
6 Madrid is more recent, because the capital city was born with Philip II.
History of Economic Thought and Policy/2-2018 81
others mention the role of private operations in coffee-houses for Bourse trans-
actions out of the Stock Exchange, and information. They refer to the schedules
adopted (from noon to 3pm, with the 1st hour reserved for government bonds),
and provide condence in telling how bribery, felony, and fraud gave place to
lose the brokerage position, monetary nes and criminal penalties. Ethics regu-
lated the ofcial brokerage profession: secrecy, responsibility (brokers make a
deposit as a guarantee to get the job, in some country systems).
Many books of wide practical and educational interest on the stock markets
were available, in a cultural context in which economists had already estab-
lished the market theory, from Adam Smith, David Ricardo, Thomas Malthus,
Jean Baptiste Say, James Mill, John Stuart Mill, and John E. Cairnes, to Alfred
Marshall, Carl Menger, Friedrich V. Wieser, and Eugene V. Bohm-Bawerk, to
quote only the most popular and well-known authors. Connections to Finance
also existed in some of them:
Cairnes, Mill’s most outstanding disciple, in his comments on the text of the fth edition
of the Principles, defended the joint stock principle (…). Mill (…) inserted a paragraph
embodying Cairnes’ observations in the sixth edition (Schwartz 1972: 139-140).
To the extent that their contributions were spread among businessmen, in-
tellectuals, and academicians, the understanding of Stock Exchange operations
could be improved, as Exchanges also work as a market, which is quite clear in
Courtois (1902), for whom trading is absolutely required for producing and con-
suming. Moreover, economic progress was identied with credit and the funding
via stock markets, because the foundation of a limited liability corporation is
based on shares that raise the capital for the business purposes (Graziani 1904).
This was the way to support a labour division economy.
Commodities and nancial asset transactions could now work in different
places as well as in the same. But limitations on who could or could not partic-
ipate in Stock Exchange operations became a feature of the literature. Insolvent
and bankrupt persons and all those who had failed to fulll stock exchange re-
quirements were barred from the sessions. Also excluded were those convicted
or merely accused of crimes, as were insane persons and the children. Unless
they had their own business, women were also refused entry in the commercial
codes of most countries (Ulrich 2011: 151-154).
Many of the earlier authors were aiming at an academic readership audience,
and were even more interested in nancial speculation on Stock Exchange as-
sets and price behaviour. This is the case of Jules Augustin Fréderic Regnault
(1863) and his square-root-of-time rule (Preda, 2004: 351): “L’écart des cours
est en raison directe de la racine carrée des temps”. Based on the intuition of
Brownian motion, he provided a picture of a very narrow subset of scale rules
for stock market uctuations. Financial speculation and horse-race gambling
stimulated calculations for the use of probabilities. As Christian Walter (2000:
3) says: “There has always existed an interaction between empirical knowledge
and theoretical models.” Henri Lefèvre Chateaudun, who was a private secretary
82 M. E. Mata, J. Rodrigues da Costa, D. Justino/ Finance, a New Old Science
of Rothschild, became a banker, and published the Traité des valeurs mobilières
et des opérations de Bourse: Placement et speculation, (Treatise on securities
and Stock Exchange operations), for nancial speculators, in 1870:
In the late 1860s, Lefevre started a nationwide investment company called Union Fi-
nancière and published an investment journal, the Journal des placements nanciers. In his
Traité, he developed the graphic method known as the ‘payoff diagram’ (Preda 2004: 351).
According to David Supino (1898) it is wrong to blame stock markets for
speculation, because they belong to capitalist economies and are a necessary
element of capital circulation, interest rate convergence, and price equilibrium.
Market efciency was commonly assumed as a basic fact, and Supino believes
in it.7 In his opinion stock markets facilitate trading and exchange, so accusations
against Stock Exchanges are similar to those against machines, factories, and
new technologies.
Arbitrage is important, we say now. The activity was already considered to
be highly important to society by Hayaux du Tilly (1901), arguing that while
trading in commodities interests only some people, everybody must recognize
that nancial assets serve everybody. In his opinion, this means that governments
cannot be blind toward Stock Exchanges, but should keep them under the scru-
tiny of the central state. Such a concept is close to regarding Stock Exchange
functions as a public good, to be preserved, implemented, and regulated.
This was not the common opinion in the early days, when self-regulated Ex-
changes arose following merchants’ and traders’ initiatives, and these competed
for their intermediation role (Stringham 2002: 2). Individuals’ associations in
Britain and Northern continental Europe freely discovered the best organizational
and governance principles, by themselves without state regulation. However, in
the late nineteenth century and early 1900s, voices calling for state regulation
became loud and quite effective. Political economy textbooks included denitions
of Stock Exchanges as concentrated markets located in large urban trade centres
where businessmen met for negotiations and transactions involving large amounts
of capital (Colson, 1903, vol. 2). So too, the rules for operations and penalties
pertaining to brokers’ activity were meticulously described, especially regarding
unfair competition among them and false rumors (Moysen 1904). Self-regula-
tion/state regulation is a frequent debate wherein it is heard that one’s liberty
may collide with anothers’ liberty, which justies state regulation to maximize
societal welfare. This explains why (Commercial) Codes or special laws were
regulating Stock Exchanges (from the 1830s to the next decades): 1829-31 in
Spain, 1833 in Portugal (Ferreira Borges), etc. (The USA moved in this direction
much earlier, in 1792, thanks to Alexander Hamilton’s public loan, the Bank of
the USA, and the NY Stock Exchange’s creation and regulation).
Punishments were prescribed, and textbooks commented on these various is-
7 For the abandonment of the efcient markets hypothesis, Haugen 1999.
History of Economic Thought and Policy/2-2018 83
sues, thereby spreading information and nancial literacy (Thaler 1900). Detailed
regulations for Stock Exchange or brokers’ codes sometimes also included the
opening hours, duration of the sessions, timing for short-selling, and the schedule
for term (derivatives) transactions.
The recognition of the utility of Stock Exchanges for the economic system
comes also from the need to collect small-pocket savings for government loans in
public debt. Because condence in governments increases bonds’ prices (Ulrich,
1906: 55, quoting Piccinelli, 1897), stock markets reect a nation’s vigor and
credibility, it is said. As capital mobility is an important condition for private
businesses and public credit in all countries, its efcient provision by Stock
Exchanges for public works and collective improvements make governments
dependent on them, while regulating their activity, simultaneously (Ulrich 1906:
65, quoting Laveleye 1898).
Taxes on Stock Exchange operations were (and still are) a difcult matter.
On the one hand, it is considered that the access to stock market services should
be simple, cheap, and attractive. On the other hand, nancial operations provide
means for increasing production, distribution, selling, and the opportunity for
such benets should be taxed (Weil 1902). What taxes and what rates might
be adopted, and what the effects on nancial operations may be is a technical
discussion that already existed in the early twentieth century.
Transactions (on commodities or securities) were seen as the highest expres-
sion of alternative uses for capital (transfers among shareholders’ hands in the
vast world of business. In this way, Stock Exchanges were viewed as a barometer
of economic wealth in a capitalist society, according to Proudon’s sizeable book
Manuel du spéculateur à la Bourse.8 As a philosopher, he identied stock markets
as hidden engines of nancial civilizations, whose importance is greater than uni-
versities, theatre, conferences, courts, or the Church’s power. In his surplus-value
theory, Marx describes prots and interest as rewards for capitalists according to
the amount of capital advanced for the productive system (Marx 1901).
The investors’ perspective, however, was the dominant approach. It was
explained that if investors preferred safe and risk-free applications the interest
rate would be lower, while if they accepted some risk they could get much higher
rewards for the capital invested (Lafargue, 1897). In the rst case it was usual
to obtain capital at a 3% interest rate (or even less), and families with children
might need to accept such a modest return, while risk lovers could look for
higher rewards, against the possibility of suffering future losses. Paul Lafargue
(Marx’s son-in-law) came to the conclusion that risk and revenue were highly and
positively correlated and expressed it in a very clear way. The mix of decisions
is considered as a normal behaviour. He is not far from the idea that risk-lovers’
investment in announced and listed securities or projects is undertaken so that
the estimated (or expected) return may surpass (or at least equal) the market-de-
termined risk-free rate.
8 A 511-pages book.
84 M. E. Mata, J. Rodrigues da Costa, D. Justino/ Finance, a New Old Science
A more mechanical view establishes that Stock Exchanges provoke centripetal
and centrifugal forces, according to international competition and organization
rules for their operations (Sayous 1898). Law and legal codes sought to iden-
tify and clarify the shareholders’ rights when the established legal proceedings
were followed (Boudon 1896). Not only did they pursue this function, but it is
fair to also recognize the pedagogical character of these books in disseminating
knowledge on nancial markets, and in providing nancial literacy to users
(Chevilliard 1904). They offered real guidelines for action in describing Stock
Exchange operations and the agents in them (Bozerian 1859).
Many books may also be considered as glossaries for nancial vocabulary,
as there is a technical language made of special words and expressions in each
language (Fontaine 1905). These books often presented considerable information
on banking issues, securities in general, and public debt (Ferraris 1892). They
provided training in reasoning about nancial matters in a political economy
perspective (Boudon, 1898). The entries on Bourse at Dictionaries, are summa-
tions (Raffalovich 1900; Vidal 1896).
Ruy Ennes Ulrich (1883-1966) also wrote a textbook in Portuguese On Stock
Exchanges and their Operations (Da Bolsa e Suas Operações). This was his
doctoral dissertation topic at the University of Coimbra Law School, in 1906.
He mentions a number of important books then available in France (36), Italy
(11), Spain (Carreras y Gonzalez, 1865), Germany (Gründt 1899), and the UK
(Passos 1905), as having rened treatments of legal matters, as well as discus-
sions of regulations and organizational features of the Stock Exchanges (Ulrich
1906; Mata and Costa, 2013). It is quite clear that Ulrich’s concept of equilibrium
stems from some elds of Physics, and comes through a large bibliography, with
a dominant French character.
If a mathematical approach is required to dene the scientic character for
contributions, we may cite the pioneering work of Louis Bachelier (1870-1946),
The Theory of Speculation in stock markets, from 1900, which is a seminal intro-
duction to the concept of stochastic processes to mathematically describe stock
price evolution (Preda 2003). He may be rightly considered as a founding father
of nancial mathematics, in creating the Brownian motion model to evaluate
stock options. According to Alex Preda (2004: 351):
Louis Bachelier appears (…) as one member in a series of economists intensely preoc-
cupied with developing nancial economics. This, however, does not diminish his merits:
Bachelier was a creative developer of ideas and preoccupations that other economists had
already formulated.
This mathematical contribution is usually considered to have met with little
success in the French academy. It was presented as a doctoral dissertation at the
Sorbonne, in Paris, and was approved, but without distinction. It also gained
little recognition thereafter (MacKenzie 2002). No teaching position was offered
to Bachelier in Paris, who found his rst teaching position only in 1909 and a
permanent position only in 1927, in Besançon, which was a remote university
History of Economic Thought and Policy/2-2018 85
in comparison with his alma mater. Nowadays, Bachelier is considered as a real
forerunner, and there is an analysis on the dissemination of his work in economics
(Jovanovic 2012).
Mathematic contributions to Economics often left their pioneering authors
in oblivion, and Bachelier may have been only one among many. Cournot’s
theories on monopoly, duopoly, oligopoly, and perfect-competition markets are
perhaps the most well-known case. They were made available in his book Re-
cherches dans les Principes Mathematiques de la Théorie des Richesses, which
was published in 1838. Although he pursued an academic career and managed
to reach a rectorship position, few had come to understand their importance by
the date of his death, in 1877 (Ekelund and Herbert 1975: 209).
Most authors had a wide variety of professions. From philosophers to law
practitioners, from businessmen to academic professors, some of them devoted
their lives to management and worked as CEOs or executives in large corpora-
tions, using their nancial expertise in the management and strategic governance
of large domestic or international businesses (Mata and Costa 2013).
But this tide of literature was interrupted (Roberts 2013):
In London, the world’s foremost nancial centre, the week before the outbreak of the
First World War saw the breakdown of the markets, culminating with the closure for the rst
time ever of the London Stock Exchange on Friday 31 July. Outside the Bank of England a
long anxious queue waited to change bank notes for gold sovereigns. Bankers believed that
a run on the banks was underway, threatening the collapse of the banking system – all with
the nation on the eve of war.9
3. A new scientic eld after an epistemological revolution in the 1950s
It is recognized that the 1920s and the Great Depression (1929-1933) strongly
stimulated thought about stock markets, especially in the USA (Grifss 1925.
New York Stock Exchange, 1936). The textbook by Benjamin Graham and Da-
vid Dodd, Security Analysis, published in 1934, is a good example to mention,
and John Burr Williams’ Theory of Investment Value, published in 1938, is also
important. Both books were very popular in the USA, where New York was the
leading nancial centre of the world. The bubble and the crash brought a com-
pelling stimulus for nancial information on stock markets or, at the very least,
curiosity about the subject (Kindleberger 1987).10
In Europe the scientic interest for nancial markets was largely spread
throughout all countries much earlier than the 1929 crash.11
The decades following the War were difcult times, too, in one way or another
(Milward 1987). The inter-wars period remain as a break between the two huge
9 Available at https://itunes.apple.com/br/book/saving-city-great-nancial/id784312364? mt =11.
10 In Spain, Galvarriato 1935 is a good example, for its extensive inuence.
11 There is also some American literature. Werner and Smith, 1915.
86 M. E. Mata, J. Rodrigues da Costa, D. Justino/ Finance, a New Old Science
conicts, while the second half of the century would bring reconstruction and
prosperity (Aldcroft 1987).
The post-war context witnessed a tremendous turning point in the science
of Corporate Finance in the second half of the twentieth century (Poitras 2005).
Contributions in the 1950s to Corporate Finance and the mathematical develop-
ment of this scientic eld reect not only the historical conditions, but also the
benet from a new technological revolution based on computers and program-
ming. This is the generation that could support analytical approaches on long
time series and empirical evidence for checking the accuracy of mathematical
models thanks to superior computational calculations (MacKenzie 2006). The
introduction of risk modelling in the 1950s with the mean-variance framework
can be thought of as an epistemological breakthrough for nancial practices.
The reticence of asset managers to adopt the new way of thinking about fund
management is an example of the consequences of the intellectual revolution
introduced by mean-variance risk analysis in a specic professional activity
(MacKenzie 2006; Walter 2002).
According to Miller’s (1999) history of Finance, the 1950s were the break-
through decade for intellectual achievement in Finance and Financial Economics,
thanks to Corporate Finance and the Asset Pricing Theory. The epistemological
watershed was very clear, and consisted of introducing mathematical modelling
methodologies. The scientic developments achieved in the eld are today uni-
versally praised and globally recognized. Eight economists received a Nobel
Prize in Economics for their contributions to Finance.
In 1990 the Prize was awarded to three authors, Harry Markowitz, William
Sharpe, and Merton Miller. Curiously, when Markowitz concluded his Ph.D.
at the University of Chicago, Milton Friedman opposed the dissertation on the
ground that it was not really economics. This assertion in fact heralded the spe-
cialized character of Corporate Finance, and resulted from considering that it
was an exotic approach that was being pursued for practical aspects related with
transactions in stock markets (Rubinstein 2003). Harry Markowitz’s research
mainly brought contributions on the discount value of future returns. William
Sharpe developed the capital-asset pricing (CPAM) model, which has been an
important instrument for applications in the social eld of retirement pensions. As
demography became a major problem in the developed societies of the Western
world, a result of the low birth rates and the increasing weight of the elderly, the
failure of social schemes for pensions has provided great importance to Sharpe’s
nancial research on retirement pensions. The Keynesian Franco Modigliani’s
views on this subject include the life-cycle model, but his co-operation with
Merton Miller mostly led to the study of rms’ capital structures. In considering
the ways for funding rms, a famous Modigliani-Miller (M-M) theorem put an
end to the idea that corporations could reduce their cost of capital by achieving a
correct debt-to-equity ratio. On the contrary, their M-M theorem establishes that
the value of a corporation is independent of the ways funding can be obtained: the
application of prots to expenditures, borrowing, or the issue of more shares to
History of Economic Thought and Policy/2-2018 87
increase capital are considered to be independent means to solve funding needs,
and the weights of these sources of funding do not affect the value of the rm.
In fact, the present value of an investment was understood as the expected
value – that is, the probability-weighted mean value – of its possible future
outcomes (Stabile 2005). For risk assessment, the variance (squared deviations
of those outcomes around the mean) was proposed as a good measure. Such an
approach stresses the importance of statistical evidence of past experience in
stock markets, as time series treatment is crucial for these estimations. Return
and risk were identied with mean and variance. For these reasons, Corporate
Finance stimulates economic history studies on stock markets, and paves the
way to co-operation with economists who devote their research to economic,
business, and nancial history. A good example of such co-operation is the
estimation of the Cost of Capital, as it is based on long-term time series from
historical datasets that record daily observed values.
Seven years later, in 1997, Robert Merton and Myron Scholes were also
awarded the Nobel Prize for introducing option pricing and Algebraic and
Mathematical Statistics for stock options and portfolio selection, thanks to a
new method to determine the value of derivatives. As the 1970s were a decade
in which debates between Keynesians and Monetarists were very intense, Robert
Merton also gave his attention to life-cycle nance, and approached portfolio
management, as well as systemic risk. Most economists believe that Fischer Black
would have also accompanied them, but he had passed away two years before,
in 1995. He was equally trained in programming and computers, and explained
booms and busts in a way that is different from what macroeconomics could
suggest. In studying the pricing of options and corporate liabilities in co-operation
with Myron Scholes (Black and Scholes 1973), they used a partial differential
equation, which became known as the Black-Scholes equation, and concluded
that “a boom is a period when technology matches well with demand”, and a
bust is a period of mismatch. The Black-Scholes equation, as Robert Merton
labelled it, was a major contribution.
In 2013 the Nobel Prize was given to distinguished contributors in Finance,
Eugene Fama, Lars Peter Hansen, and Robert Shiller, for their empirical analysis
of asset price. Eugene Fama made explicit Bachelier’s efcient-market hypothe-
sis, while Lars Peter Hansen, an econometrician and macroeconomist, applied a
generalized method of moments (GMM) to asset valuation, and looked at nance
with rational expectations hypotheses for uncertainty to solve the equity-premium
puzzle discovered in macroeconomics. A great interest in the equity Premium
was spread among macroeconomists, who devoted their attention to general-equi-
librium models. Rajnish Mehra and Edward Prescott (1985) used an 1889-1978
database for GDP and Consumption in the USA and concluded that Arrow-Debreu
asset-pricing models could not explain the high (American) equity risk premium
and the small average risk-free return that were historically observed. Thomas
Rietz (1988) re-specied their model for a frictionless pure-exchange economy
and solved the puzzle in capturing the effects of (possible) market crashes in
88 M. E. Mata, J. Rodrigues da Costa, D. Justino/ Finance, a New Old Science
abandoning the hypothesis that consumption growth rates are symmetric about
their mean and fall above their mean as often as they fall below. Reasonable de-
grees of time-preference and risk aversion were revealed, provided that plausibly
severe crashes are not too improbable in long-term analysis.
Although crises are unlikely phenomena, they do occur. Robert Barro and
Jose Ursúa (2008) go into full annual data on Consumption for 22 countries to
detect crises, as this is the variable “that enters into usual asset-price equations”.
To enlarge the sample they also use GDP for 35 countries. For samples starting
as early as 1870 (as is the case for Portuguese GDP estimations) a peak-to-
trough method was used for each country to isolate economic crises (dened
as cumulative declines in Consumption or GDP of at least 10%): 87 crises for
consumption and 148 for GDP were discovered, leading to the conclusion that 3.5
years was the average duration for disasters, having a mean of 21-22%, under a
coincident timing in both Consumption and GDP. The conclusion is that a Lucas
tree-model with i.i.d. growth shocks and Epstein-Zin-Weil preferences accords
with “the observed average equity premium of around 7% levered equity”, after
supposing that 3.5 was the coefcient of relative risk aversion.
In conclusion, an important dialogue was established between nance, mac-
roeconomists, and economic historians in looking for evidence from the large
laboratory of experiences and facts that history makes available whenever long-
term analyses are pursued (Miller 1999: 96): “The characteristic economics de-
partment approach (…) is not micro, but macro normative”. The stock-exchange
variables are now a decisive topic for the global scientic community and for
theoretical paradigms of different schools of economic thought.
Hansen’s work exemplies the importance of empirical studies, which did not
prevent Hansen from bringing a very important theoretical contribution, which
is the need of separating the concept of risk from uncertainty.
All these contributions from Nobel laureates show that corporate nance did
not evolve irrespective of economic thought. On the contrary, they are in close
connection with it. The 2013 Nobel laureate Robert Schiller, from Yale, paid
attention to behavioural nance, beneting from the most recent inuences of
psychology on economics. Close attention to global business-cycle uctuations
was also present in Schiller’s work, such as the 2007 crisis, and the nancial
market volatility. Having professional impact on economic policy after consid-
ering the metrics of rises in real estate as a bubble, Schiller challenged the ef-
cient-market hypothesis in considering the future falling prices, rising defaults,
closures, and possible panic. In considering the existence of different ideas on the
market nature, the accuracy of his forecasting abilities have become important
results for elds ranging from scientic nance to macroeconomics of business
cycles. Accuracy in forecasting conrms the objectivity and precision of Finance
studies. As Miller (1999: 96) says:
The models assume a world of micro optimizers, and deduce from that how market
prices, which the micro optimizers take as given, actually evolve.
History of Economic Thought and Policy/2-2018 89
Conclusion
Many decades before the introduction of nancial economics, investment
strategy, and the study of risk in asset investments by American experts in the
1950s and thereafter, nancial knowledge was based on experience, observation,
and investment decision-making processes that were dictated by the particular
needs of the time. Main contributions may be quoted from English, French, Ital-
ian, German, and Portuguese Authors. They all pioneered the study of corporate
nance and nancial markets, in offering substantive textbooks for nancial
markets users. Their knowledge and the practical character of their discussions
were very rich and useful at a time when the balance of nancial power was still
in the European cities and their nancial markets, although New York was gaining
an important role on the other side of the Atlantic (Sylla 2010). As forerunners
in the eld of Financial Thought, they all deserve to be considered as the rst
wave of contributors in the history of the eld.
Are the story of early nancial literacy and the story of mathematical modern
nance two stages of the same story?
Yes, this paper concatenates the two strands of literacy that are linked to-
gether. As in many other elds, in the History of Financial Thought, one may
point out a bias toward the preference for recent important developments, and
mathematical contributors. This should not lead us to forget the many traditional
forerunners. Most of them were non-mathematical and non-English language
contributors. These often-overlooked authors, some of whom were well-trained
economists, paved the way in spreading common and practical knowledge,
to vast numbers of the global population. The issue of risk analysis has been
important to understand the transformation of nance, passing from European
authors’ non-mathematical approaches to the contemporary mathematized and
computational nancial practices (Lafargue1897, for example).
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abstract
Corporate Finance is a fashionable eld in schools of Economics throughout the World.
Although the main epistemological break to identify its scientic character may be established
in the decade of the 1950s, this paper demonstrates how much developed nancial thought
there was in Europe before the First World War. Thanks to considerable growth of interna-
tional trade, corporations, and multinationals (i.e. rising globalization) during this phase of
European civilization, Stock Exchanges ourished in all European countries. Philosophers,
businessmen, professors, and lawyers disseminated their burgeoning erudition in nancial
knowledge, and several authors made large contributions in books devoted to legal features
of human economic actions, and in textbooks devoted to political economy.
Jel Classication: B15, B16, B19, B41, G19.
Keywords: Financial literacy, European Financial Thought, nance forerunners, nance Nobel
prizes, mathematical modern nance
Submission: 2017.12.21
Accepted: 2018.06.06
