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199 of 232 people found the following review helpful:
3.0 out of 5 stars
It's the uncertainty versus risk problem all over again-2.5 stars, May 18, 2007
Bernstein still is not able( or willing) to carefully weigh the additional historical and empirical evidence that has been presented since 1996,when his " Against the Gods " appeared,concerning the reliance of " modern " finance theory on the assumption that price changes in all financial markets can be modeled on the normal distribution.Nowhere , in his previous books or in this book, is there any report of any economist/econometrician/financial analyst doing any basic goodness of fit test on the time series data from financial markets showing that it fits the normal distribution. Bernstein seems to be unaware that Benoit Mandelbrot(Mandelbrot appears not to have been mentioned anywhere in the book) has demonstrated time and again, for well over fifty years, that the data DOES NOT fit the normal distribution.If all of the goodness of fit tests demonstrate that the time series data does not fit the normal distribution but the cauchy distribution,what scientific defense can be provided to support the continued use of (a)the mean-variance model,(b)the Beta model,or (c)the Black-Scholes model ? The problem that Bernstein,and the financial analysts he supports, faces is the same problem faced by the Ptolemaic astronomers at the beginning of the 17th century when confronted publicly by Galileo .They successfully silenced Galileo in the short run but were simply destroyed intellectually in the long run as it became increasingly apparent,even to the average citizen, that the earth was not the center of the Universe,that there was no such thing as retrograde movements by the stars,and that the sun did not revolve around the earth but the earth around the sun.Apparently,Bernstein believes that the main conclusion that follows from the application of the normal distribution in portfolio analysis,that diversification of one's portfolio is the rational way to reduce risk,is so important to maintain that it is worthwhile to continue to analyze financial market price movements " as if " they were normally distributed even if all of the evidence shows this to be false.This is not the case.Many centuries before the normal distribution came to be the foundation of portfolio analysis,decision makers had been relying on the old adage that it was unwise to put all your eggs in one basket.One does not need to rely on a theoretically false characterization of price movements to come to the conclusion that diversification is a wise choice for the average investor who lacks the time,training,and experience to emulate Warren Buffet or John Maynard Keynes. Bernstein appears to be unaware that this issue, of correctly modeling the financial markets, is not a new one.There appears to be very little difference ,at least to this reviewer,between the current controversy that Bernstein ascribes to the "new behavioral finance school"(Shiller-Tversky-Kahneman) and the 1939-40 debate between Keynes and Jan Tinbergen in the pages of the Econmic Journal concerning Tinbergen's belief that he could use the method of a least squares(ordinary least squares)based multiple correlation and regression analysis to predict turning points in the business cycle by analyzing changes in the demand for investment and expectations.Keynes pointed out to Tinbergen that, due to technological change,advance(decay /obsolescence),innovation, and constant changes in expectations of the future,the time series data would not be "...uniform,stable,constant,or homogeneous" over time.The mechanism or propagation machine,which can be represented by some type of probability distribution,generating the time series data would be changing over time.Keynes politely asked Tinbergen to apply some type of goodness of fit test to establish the dynamic stability of the time series(Keynes,in his 1921 A Treatise on Probability,suggested the Lexis-Q test in chapter 33).Tinbergen never supplied Keynes,or anyone else in his life time,with any goodness of fit test.This is certainly a strange reaction from an individual who liked to call himself an economic scientist. Bernstein is a very good writer.This book is well written.Unfortunately,Bernstein has chosen to serve up " more of the same " type of exposition that was acceptable in his earlier works but now simply begs the question.Bernstein appears to be unable to consider the possibility that advocating the mean -variance approach, when all the statistical evidence shows that the distributions are not close to being normal,is not just unscientific but anti scientific. Finally, there are a number of important contributors to the risk versus uncertainty debate that are either not mentioned or mentioned in one liners.I find it incredible that the work of D. Ellsberg on ambiguity is omitted.Frank Knight's views on the primacy of dealing effectively with the uncertainty,as opposed to the riskiness ,of the future appears not to have been discussed.Joseph Schumpeter's views on the impact of uncertainty on the business cycle ,and the inapplicability of relying on a normal distribution, due to the "regular irregularity"of technological change over time that is not predictable, are not mentioned.Keynes is given a few irrelevant one line comments in the introductory pages of the book.Mandelbrot's work is not discussed or mentioned.Taleb's work is not covered.Bernstein attempts to fill this gap by substituting Shiller,Lo,Tversky,and Kahneman.However,long before Shiller,Lo,Tversky,and Kahneman were born,Keynes and Knight were discussing these problems in great detail in their books, simultaneously published in 1921, A Treatise on Probability and Risk,Uncertainty,and Profit.
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18 of 21 people found the following review helpful:
4.0 out of 5 stars
Capital Ideas Evolving, September 19, 2007
This was not an easy read, but it was worth it. I received my MBA in 1976. Much of this book was an explanation of the effects of the Capital Asset Pricing Model (CAPM) on current investment practices. He assumes that the reader is well versed with the intricacies of CAPM. I had to go back to other sources to review CAPM, but once I did, the book was a great explanation of how CAPM and other academic innovations have had a practical effect on portfolio management. When I finished the book, I had to admit that I was not able to apply much to my personal portfolio management, but I have a much better understanding of what my pension plan administrator is thinking about as well as what certain mutual funds managers are doing. The book is more beneficial for the professional investor than the individual investor.
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4 of 5 people found the following review helpful:
3.0 out of 5 stars
The World Is Going Quant, November 14, 2008
I have a lot of respect for finance professors. To quote a felicitous expression, they perform "mathematics in flesh and blood". They are the surgeons of the modern economy, cutting through inefficiencies and making sure the blood of capital flows into the arteries of corporate accounts or personal savings. And like surgeons, society gratifies them with generous pay and social prestige: the time is over when finance specialists were snubbed by their economist colleagues and kept on the margins of the discipline. Some may even get a Nobel prize in economics, while many may complement their academic salary with management consulting or hands-on investment. All these pursuits are perfectly legitimate, and finance professors are usually nice individuals endowed with a sharp mind. But Bernstein overemphasizes their worth and gets way too far in praising their accomplishments. The chronicler turns into a sycophant when he writes that "the vigor, the freshness, and the extraordinary clarity of Samuelson's mind would be stunning to encounter in a man of any age". Or that Robert Shiller's "ingenious and restless mind seems never to come to sleep". But leaving excessive praise aside, the book makes several strong claims that I found worth considering. The first is that the era of financial theory is over. Finance as an academic discipline is based on theories--the Capital Ideas of the title, described in the prequel volume-- that were developed from 1954 to 1972, starting from Markowitz's essay on portfolio selection ("Markowitz came along, and there was light"). The consequence is that most finance academics have now left theory behind, either to launch attacks on neoclassical assumptions based on behavioral observations, or to adopt an institutional perspective on how markets work in order to design better rules and instruments for managing risk. Others have left academia altogether and have moved to the dark side of portfolio investing, where they have created structures surprisingly close to the university setting: "we conduct research; we discuss it and improve it; and we build models and empirically test them. And in some sense we publish them and verify them when we test them in the market", says Myron Scholes, a Nobel prize laureate turned investor. The concentration of discoveries in a short time span and among a small group of innovators is by no means unique in the history of science. But past experience also shows us that well-established paradigms can be radically challenged and overcome by new ideas coming from the fringe of the discipline that put past theories into oblivion. Nothing stands still. The Capital Ideas are nor written in stone. And a new theory of finance may very well emerge that will match Markowitz's approach to portfolio selection, Modigliani and Miller's insights into corporate finance, the Efficient Market Hypothesis, the Capital Asset Pricing Model, and options pricing theory. The second claim made by the author is that the Capital Ideas are not vulnerable to empirical challenge. Behavioral Finance has pointed out many situations in which the axioms of neoclassical theory do not apply, but as Andrew Lo notes, these findings are only "a collection of anomalies, not a real theory. You need a theory to beat a theory". The same applies to statistical tests, which have repeatedly failed to confirm the validity of theoretical models. For Fisher Black, another Nobel prize laureate, you should put your trust only in logic and theory, and forget about statistical empirical results. But aren't the financial models designed by theorists repeatedly proven wrong by market crashes and financial crisis, at the cost of staggering financial loss and dire economic consequences? What worth is a theory that fails to foresee those crises, or worse seems to contribute to their occurence through unfettered innovation and mismanagement of risk? Bernstein responds that the creators of modern finance were not taken by surprise by difficulties in the implementation of their models. The academics knew as well as anyone that the real world was different from what they were defining, and that the models were an approximation to reality and a guide to strategy rather than a precise replication of the world. Perhaps, but the technicians of finance went way beyond their academic masters and really believed in their models, without the necessary dose of skepticism that only a familiarity with academic research can cultivate. The third idea that I would like to comment upon is what social scientists call the performativity of economics: the idea that reality looks increasingly like the theory, that "powerful forces are constantly at work in the markets to bring the resemblance between theory and reality closer with the passage of time." The real world itself is on a path toward an increasing resemblance to the theoretical world described in Capital Ideas. Even research that focusses on the distance between theory and reality actually contribute to the convergence between the two. Behavioral Finance, Bernstein notes, is by nature self-disfulfilling, and it has become the driving force toward the Efficient Market Hypothesis that it so vigorously attacks. The CAPM may be outdated as a theoretical model, but its influence has never been so great, as it has been transformed into a powerful real-world tool for managing money and for calibrating investors' performance. Theory creates a world of our own making. But here we should stop and ask ourselves whether we really want a world shaped by financial theory. A world that has gone quant is a world unintelligible to most mortals, a world without moral compass and where things regularly get out of control. Bernstein was right in pointing toward the world-making quality of financial theory; but he fails to consider the moral and political implications of this basic intuition.
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