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Principles of Financial Economics
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Financial economics plays a far more prominent role in the training of economists than it did even a few years ago.
This change is generally attributed to the parallel transformation in capital markets that has occurred in recent years. It is true that trillions of dollars of assets are traded daily in financial markets—for derivative securities like options and futures, for example—that hardly existed a decade ago. However, it is less obvious how important these changes are. Insofar as derivative securities can be valued by arbitrage, such securities only duplicate primary securities. For example, to the extent that the assumptions underlying the Black-Scholes model of option pricing (or any of its more recent extensions) are accurate, the entire options market is redundant, since by assumption the payoff of an option can be duplicated using stocks and bonds. The same argument applies to other derivative securities markets. Thus it is arguable that the variables that matter most— consumption allocations—are not greatly affected by the change in capital markets. Along these lines one would no more infer the importance of financial markets from their volume of trade than one would make a similar argument for supermarket clerks or bank tellers based on the fact that they handle large quantities of cash.
In questioning the appropriateness of correlating the expanding role of finance theory to the explosion in derivatives trading we are in the same position as the physicist who demurs when journalists express the opinion that Einstein’s theories are important because they led to the devel- opment of television. Similarly, in his appraisal of John Nash’s contributions to economic theory, Myerson [13] protested the tendency of journalists to point to the FCC bandwidth auctions as indicating the importance of Nash’s work. At least to those with some curiosity about the phys- ical and social sciences, Einstein’s and Nash’s work has a deeper importance than television and the FCC auctions! The same is true of finance theory: its increasing prominence has little to do with the expansion of derivatives markets, which in any case owes more to developments in telecommunications and computing than in finance theory
Stephen F. LeRoy and Jan Werner - Personal Name
1st Edtion
NONE
Principles of Financial Economics
Management
English
2000
London
1-290
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