An Engine, Not a Camera: How Financial Models Shape Markets
Donald Mackenzie
Abstract
This book argues that the emergence of modern economic theories of finance affected financial markets in fundamental ways. These new, Nobel Prize-winning theories, based on elegant mathematical models of markets, were not simply external analyses but intrinsic parts of economic processes. Paraphrasing Milton Friedman, the author states that economic models are an engine of inquiry rather than a camera to reproduce empirical facts. More than that, the emergence of an authoritative theory of financial markets altered those markets fundamentally. For example, in 1970, there was almost no trading ... More
This book argues that the emergence of modern economic theories of finance affected financial markets in fundamental ways. These new, Nobel Prize-winning theories, based on elegant mathematical models of markets, were not simply external analyses but intrinsic parts of economic processes. Paraphrasing Milton Friedman, the author states that economic models are an engine of inquiry rather than a camera to reproduce empirical facts. More than that, the emergence of an authoritative theory of financial markets altered those markets fundamentally. For example, in 1970, there was almost no trading in financial derivatives such as “futures.” By June of 2004, derivative contracts totaling USD 273 trillion were outstanding worldwide. The author suggests that this growth could never have happened without the development of theories which gave derivatives legitimacy and explained their complexities. The book examines the role played by finance theory in the stock market crash of 1987 and the market turmoil that engulfed the hedge fund Long-Term Capital Management in 1998. It also looks at finance theory that is somewhat beyond the mainstream—chaos theorist Benoit Mandelbrot’s model of “wild” randomness.
Keywords:
Nobel Prize,
Milton Friedman,
financial derivatives,
futures,
finance theory,
1987 crash,
hedge fund,
Benoit Mandelbrot,
wild randomness
Bibliographic Information
| Print publication date: 2006 |
Print ISBN-13: 9780262134606 |
| Published to MIT Press Scholarship Online: August 2013 |
DOI:10.7551/mitpress/9780262134606.001.0001 |
