Capital Ideas: The Improbable Origins of Modern Wall Street is a very fascinating book that gives a detailed account of different developments in quantitative analysis of the stock market. The author uses his experience in financial management to inform his readers on the origin and dynamics of modern Wall Street. The book is an appreciation of how investment management has been transformed by new models and theories.
The author explains how the marketplace methods were changed by modern theirs and models. According to the author, institutional investment is a concept of modern finance that was developed from a variety of economic theories (Bernstein 17). Capital Ideas is a historical narrative that highlights the development of modern finance and quantitative analysis of the stock market. The author reveals to his readers the origin of modern Wall Street the relationship between modern Wall Street techniques and various research findings in modern finance.
Modern finance theories are very difficult to understand but the author tries his level best to simplify them to a level where a layman can understand and analyze them. The initial chapters of this book narrate how a doctoral thesis by a French researcher known as Louis Bachellier at the beginning of the 20th century demonstrated why it is difficult to predict stock prices in a financial market (Bernstein 49).
The author highlights the various financial market theories developed by different scholars especially those that touch on the unpredictability of stock prices. Famous economists such as James Tobin and Harry Markowitz are among the scholars who made a very significant contribution to the modern analysis of financial securities (Bernstein 79). The author narrates how investors ignored the new theories and concepts because they believed that the scholars who developed the theories were failures. Bernstein reiterates the need to have systematic risk control when it comes to investment returns (149).
The author gives a brief background on how the 1973 bare market made the reluctant investors believe in investment management theories (Bernstein 184). The book demonstrates how technological advancements, diversification, and hedging have become part of investment management (Bernstein 188). According to Bernstein, restructuring investment practices and strategies is very critical when making big investments (195).
The author of this book tries his level best to ensure that both insiders and outsiders in the capital market are in a better position to understand and predict market behavior. Portfolio analysis-risk management models have been explained in this book and the author traces their origin to give his readers a very solid background in investment management. The majority of portfolio analysis-risk management models were developed after the Second World War (Bernstein 199).
The capital asset pricing model and the standard deviation model are some of the portfolio analysis-risk management models are that the author gave priority to in his book. According to Bernstein, price movements are normally assumed to be small and independent of each other (221). The author analyzes all financial markets using general assumptions. Bernstein argues that the scholars who come up with theories that shape the financial market should be regarded as heroes and not greedy Wall Street businessmen (256). The author comes to the defense of finance scholars by writing about their role in the Wall Street transformation.
The financial crisis that was witnessed in 1974 is one of the major points of discussion in Capital Ideas. The author explains why and how the stock market crashed in that year. According to Bernstein, the bear market in common stocks led to the worst financial crisis in the history of modern finance (342). The 1987 crisis that is highlighted in the final chapters of the book is the only financial crisis that can be compared to the 1974 bear market in common stocks (Bernstein 365).
The two incidences in the stock market tainted the image of financial innovators but this was not their fault. According to Bernstein, it was wrong for investors and the general public to blame financial specialists because of what happened to the stock market during those two incidences (365). The author insists that more innovations in the finance discipline are the solution to the problems facing the financial market (Bernstein 368). The 1974 crisis challenged financial practitioners to come up with risk management theories. Portfolio selection was the other aspect of financial management that attracted the attention of economists and other financial scholars after the 1974 crisis (Bernstein 390).
Portfolio insurance was blamed for the 1987 crisis but this was just an excuse to portray financial experts as failures (Bernstein 396). The author laments how many business schools across the world are yet to appreciate finance as a very important academic discipline. The stock market was never given any attention by very prominent economists before the finance discipline was created (Bernstein 399). The book provides adequate personal and professional information about the pioneers of modern finance. Readers of Capital Ideas must have some knowledge regarding theoretical finance for them to understand the complex financial models and theorems that have been highlighted in the book (Bernstein 402).
The author responds to the various financial models and theorems in a nonscientific way to help his readers in understanding the most complex models. The most contentious question in this book is whether the stock market is predictable or not. The author dwells on the history of finance and other related disciplines. The author categorically points out his heroes when it comes to modern Wall Street reforms and innovations. Examples of the author’s heroes include Markowitz, Scholes, Modigliani, and Sharpe. The author demonstrates his support for synthetic portfolio insurance. The author focuses on the positive aspects of the finance theory by ignoring some of the perceived errors.
Financial analysts believe that the assumptions used to build the financial models in Capital Ideas had some errors. The CAPM is the most notable model with flawed assumptions. The author does not in any way point out the errors in some of the theories even though some of them are quite obvious. The author uses very interesting stories to communicate his message effectively. The book dismisses Dodd and Graham’s methods of value investing which is not a good idea (Bernstein 405).
The theories and ideas in this book are very useful to both investors and finance students. Bernstein insists that the ideas in the models discussed in the book are very sound despite the flaws in the assumptions used to build the models (474). The author argues that the models used in the book should not be dismissed because they have some errors but should only be seen as the basis for future advancement in modern finance (Bernstein 481). The author acknowledges that lack of data and processing power is the reason why it is difficult to understand some of the most complex theories (Bernstein 408). Investors should not in any way ignore this book unless they want to fail.
The history of quantitative analysis of the stock market has been tackled in detail by the author. Godman Sachs and Wells Fargo are some of the new generation scholars mentioned in the book. The author gives a historical explanation of the 1987 financial crisis by giving a detailed analysis of portfolio insurance and systematic risk (Bernstein 410). Although the majority of the theories and models in the book are very complex, the author does his level best to hide the complexities.
Complex models such as the options pricing model and the capital asset market pricing theory have been simplified by the author. The author was aware of the fact that presenting them in their original form would make it difficult for him to pass his message to scholars and investors (Bernstein 412). Capital ideas is a very interesting book to read because the author uses very simple and persuasive language that can be understood by his readers. It is important to note that the book covers theories and models that were formulated before 1992. Modern quantitative technologies such as Stochastic Calculus were not ready by the time the author was publishing this book.
Capital Ideas is a must-read for finance students and investors because it analyzes the stock market by highlighting some of the most important investment management developments. The author highlights some of the most important theories and models by famous scholars which have been instrumental in shaping the stock market. The author highlights the evolution of the stock market from a historical perspective. The book explains how quantitative analysis of the stock market has developed over the years in a very simple and understandable language.
Works Cited
Bernstein, Peter. Capital Ideas: The Improbable Origins of Modern Wall Street, New York, NY: John Wiley, 2012. Print.