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Capital Ideas Evolving Hardcover – May 4, 2007

ISBN-13: 978-0471731733 ISBN-10: 0471731730 Edition: 2nd

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Editorial Reviews

Review

"In both its sweeping account of investment ideas and the depth of the author’s insights, Capital Ideas Evolving is unmatchable." (Financial Analysts Journal, July/August 2008)

FIFTY years ago, the business of managing other people's money was very much an art not a science, and was largely a matter of finding someone who was privy to inside information. But during the 1950s, 1960s and 1970s, academics changed the study of what became known as portfolio management. They did so in the face of much initial resistance and scepticism from the industry.
In his 1992 book, "Capital Ideas", Peter Bernstein gave a magisterial account of the academics' thinking. The likes of Harry Markowitz, Bill Sharpe and Myron Scholes developed theories to explain the link between risk and reward, the gains to be made through diversification and the framework for valuing financial options.
In recent years, however, some of these concepts have come under attack. Critics have argued that the academics used too many simplifying assumptions, such as ignoring trading costs. A school of thought, known as behavioural finance, has proposed that investors are not as rational as the models assume and are subject to psychological biases, such as a reluctance to cut their losses.
Now Mr Bernstein has returned to the fray with a new volume in defence of his academic heroes. Although he accepts some of the theories' limitations, he argues that the professors built the structure for today's capital markets. Modern investors are much more sophisticated in the way they think about risk, in particular separating the returns available from market movements (beta in the jargon) and managerial skill (alpha).
The academic concept of efficient market theory—that prices already reflect all available information—has led to the creation of index-tracking funds that allow investors to own a diversified portfolio at very low cost. Although behavioural financiers have spotted market anomalies, they have not shown that these can be systematically exploited: the average fund manager still struggles to produce a return that matches the index.
Indeed, Mr Bernstein seeks to show how financial giants such as Barclays Global Investors and Goldman Sachs Asset Management have built on the insights developed by the academics. If there are ways systematically to beat the markets these days, they probably require men with physics doctorates and massive computer power rather than a smooth manner and the right contact book.
There is the equivalent of a technological arms race as modern fund managers vie to find the best computer models and to trade quickly before their competitors spot the same opportunities. This race is making the markets more efficient, and so making the academics' models look more realistic than before.
As Mr Bernstein recognises, this frantic activity is something of a paradox. The academics have taught us to be suspicious of the claims of the investment industry. But if the fund managers were not beavering away trying to pick stocks, prices would not be set efficiently and the academics would be proved wrong.
Lacking its predecessor's historical sweep, this book is not quite as impressive a feat of scholarship. But Mr Bernstein has yet again produced a book that is insightful and thought-provoking. (The Economist, June 15, 2007)

"…a challenging sequel to (and spirited defense of) his 1992 classic" (Bloomberg, Friday 8th June)

"Mr Bernstein has returned to the fray with a new volume in defence of his academic heroes. Although he accepts some of the theories' limitations, he argues that the professors built the structure for today's capital markets...a book that is insightful and thought-provoking." (The Economist)

"Mr Bernstein has yet again produced a book that is insightful and thought-provoking." (The Economist, 15th June 2007)

"…an enthusiastic study of the academics whose theories have revolutionised global markets…also a great primer in the ideas that currently govern the way the world’s money is invested." (Financial Times)

"Brilliant...This book should be in your library" (MarketWatch)

"…an enthusiastic study of the academics whose theories have revolutionised global markets…also a great primer in the ideas that currently govern the way the world’s money is invested." (Financial Times,  Mon 2nd July) 

"satisfying read" (Capital Ideas Evolving, Monday 6th August)

"a clear and elegant introduction to the debate, including vignettes of all the main intellectual figures"  (Financial Times, Saturday 15th December 2007) 

"… an excellent introduction to…modern portfolio theory and will appeal to academics, practitioners, and to others who study financial markets." (Pension, Economics and Finance Journal (PEF), Vol. 7/2 08)

From the Inside Flap

In all of history and in all fields of intellectual endeavor, a tension has existed between theory and practice. Those of us who earn a living in the real world seldom want to appear as slaves to some set of abstract ideas. It was no surprise, therefore, that the word "baloney" was Wall Street's greeting to the pioneering theories of finance developed by a small group of academics in their ivory towers during the years from 1954 to 1972. Yet those breakthrough theories would in time earn five Nobel Prizes in Economic Science. Baloney they were not.

In Capital Ideas Evolving, today's foremost financial historian expands upon his groundbreaking book of 1992, Capital Ideas: The Improbable Origins of Modern Wall Street, to recount how these financial theories finally migrated from the towers of ivory to the towers of glass on Wall Street and other financial centers around the world. The result has been a global revolution in the nature of financial markets, the menu of investment strategies, the development of exotic financial instruments, and the role of an uncertain future in all investment decisions. Even the academics who originally developed these theories are active today in the markets and in the creation of new financial structures and strategies.

The opening pages of Capital Ideas Evolving confront the attack on these theories from researchers in Behavioral Finance, who argue that the theoretical assumptions of fully rational investors are a far cryfrom reality. Bernstein finds strong positive conse-quences in the daily interaction between these critics and the impact of financial theory. Based on personal interviews with leading practitioners and theorists—including five of those who played a prominent role in Capital Ideas—this book also describes how today's key practical applications developed from the core ideas of finance theory into the new and exciting formats of the investment process found in today's environment. This story includes the startling success of a group of leading institutional investors, all of whom developed their strategies from a base composed of the principles once categorized as "baloney."

As Bernstein traverses between financial theory and a history of modern financial innovation, he gives us a vivid and enlightening view of today's investment world. This engaging and insightful book brings to life the individuals, ideas, and issues that are transforming the financial landscape.

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Product Details

  • Hardcover: 312 pages
  • Publisher: Wiley; 2nd edition (May 4, 2007)
  • Language: English
  • ISBN-10: 0471731730
  • ISBN-13: 978-0471731733
  • Product Dimensions: 6.3 x 1 x 9.2 inches
  • Shipping Weight: 1 pounds
  • Average Customer Review: 3.9 out of 5 stars  See all reviews (8 customer reviews)
  • Amazon Best Sellers Rank: #489,737 in Books (See Top 100 in Books)

More About the Author

Peter L. Bernstein's nine books include the worldwide bestseller Against the Gods: The Remarkable Story of Risk. Bernstein is also an economic consultant and publisher of Economics and Portfolio Strategy, a semimonthly letter for institutional investors.

Customer Reviews

3.9 out of 5 stars
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Most Helpful Customer Reviews

205 of 240 people found the following review helpful By Michael Emmett Brady on May 18, 2007
Format: Hardcover
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.
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22 of 25 people found the following review helpful By Timothy J. Powers on September 19, 2007
Format: Hardcover Verified Purchase
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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15 of 21 people found the following review helpful By Rolf Dobelli HALL OF FAME on August 2, 2007
Format: Hardcover
In the early 1950s, graduate student Harry Markowitz presented his Ph.D. dissertation to the University of Chicago economics department. The response was less than encouraging. "This isn't a dissertation in economics," Milton Friedman told Markowitz. "It's not math, it's not economics, it's not even business administration." Whatever it was, Markowitz's heterodox theory of portfolio selection changed finance forever and earned a Nobel Prize. Financial historian and investment manager Peter L. Bernstein humanizes his saga of great shifts in financial theory by organizing it around eminent thinkers (Markowitz, Myron Scholes, Franco Modigliani, Robert Merton, Bill Sharpe and others, if you ever want to look up a finance guru). Deepening his analysis with insights from "behavioral finance," Bernstein describes how these innovators generated and extended the now-orthodox "capital ideas" of portfolio selection, capital structure, the Capital Asset Pricing Model, the efficient market hypothesis and the Black-Scholes-Merton theory of option pricing. Bernstein's erudition is dazzling, his explanations pellucid and his narrative filled with scintillating characters. getAbstract doesn't need to hedge: you'll find this overview of current finance theory and practice brilliant, even if you don't know your alpha from alfalfa.
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Format: Paperback
The book is great, very well written and is an enlightening discussion about the evolution of modern finance. I usually recommend the book to my students, so they can put all what I am teaching in a historical perspective, as well as grasp the core intuition on the subjects. The book is perfect for that.

But what motivated my comment was another comment by Michael Emmett Brady. I think it is important to point out the mean-variance problem, but I beg to fundamentally differ from Mr. Brady. Mean-variance IS NOT, AT ALL, a foundation of neoclassical finance. Rationality is. Markowitz himself recognized that he was doing a simplification, because the math gets messy in a more general case (i.e. when you take into account higher moments as asymmetry and kurtosis). There is a well established body of literature, and neoclassical literature, that discusses modern portfolio theory when the distributions of asset returns are not jointly elliptical (they do not need to be multivariate normal for mean-variance to hold, they need to be jointly elliptical). The problem is that this literature has not made into most colleges' benches yet. As an example, you may refer to "Multi-moment Asset Allocation and Pricing Models (The Wiley Finance Series)", by Emmanuel Jurczenko (Editor), Bertrand Maillet (Editor), Mark Rubinstein (Foreword). In the first chapters it is possible to see how complicated things get by considering higher moments. But the Capital Ideas (as Bernstein like to call neoclassical finance) are all there.

Bernstein went to the core of the question when he chose to discuss rationality, bounded rationality and behavioral finance. Higher moments portfolio optimization may be well embedded in neoclassical finance, and the inclusion of the discussion about mean-variance approach limitations is a fair suggestion in its own right, but it does not diminishes the value of Bernstein's discussion in any way.
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