A Brief History of Financial Economics for Actuaries
This chapter gives an historical overview of the emergence of some of the key ideas in financial economics (the branch of economics concerned with fields such as securities pricing, portfolio theory, corporate financial and investment theory and the behaviour of financial markets). Financial economics was not developed by actuaries. You may well ask why it is included in a history of actuarial thought. The answer is that, rather like probability and statistics, once its foundations had been developed, its ideas had important practical application in the world that actuaries occupied. As these ideas emerged, the actuarial profession had to determine how to incorporate the new insights provided by financial economics into its thinking and practices (and, indeed, where theory did not translate into practice). This was not an easy process, as these insights were often incongruent with the traditional actuarial perspective. It triggered great actuarial debate: was this incongruence merely a result of the theoretical and unworldly nature of the economic studies, or did it signal that some key areas of actuarial thought needed fundamental revision? This process is arguably still underway. It is one of the more interesting and fundamental aspects of the historical development of actuarial thought in the second half of the twentieth century. To really appreciate it, we need to understand something of the ideas of financial economics and how they originally developed, and this is the object of this part of the book.
Our historical survey of financial economics focuses mainly on the remarkable quarter of a century of activity bookended by the seminal papers of Harry Markowitz in 1952 and Oldrich Vasicek in 1978. This period saw the development of a handful of interrelated ‘big ideas’ in financial economics that © The Author(s) 2017
C. Turnbull, A History of British Actuarial Thought, DOI 10.1007/978-3-319-33183-6_4
radically altered theoretical understanding and business practices in areas such as investment portfolio management, corporate finance, asset pricing and risk management generally and derivatives pricing and hedging in particular. We also note the important empirical research of the 1980s that challenged the ‘classical’ financial economic theories of the earlier decades and pointed to a richer, more complex economic reality.
The historical summary below is not intended to be an economics textbook. Rather it is meant to provide an overview of how and when the essence of the key ideas in financial economics emerged (particularly the ones that were potentially of practical relevance to actuarial thought). The discussion of how actuaries did and did not integrate these ideas into their thinking arises more fully in the later parts of the book, which focus on post-war British actuarial thought in life, pensions and general insurance.