Capital Ideas and Market Realities: Option Replication, Investor Behavior, and Stock Market Crashes [Paperback]

Bruce I. Jacobs (Author), Harry M. Markowitz (Foreword)

Book Description

ISBN-10: 0631215557 | ISBN-13: 978-0631215554 | Publication Date: August 11, 1999 | Edition: 1

Bruce Jacobs sifts through the history of modern finance, from the efficient market hypothesis to behavioral psychology and chaos theory, to determine the cause of recent market crashes.

• Includes a Foreword from Nobel Laureate Harry M. Markowitz.
  
• Showcases the expertise of an author who identified and predicted the causes of 1987, 1997 and 1998 crashes.
  
• Explains the risks of little-understood option replication.
  
• Offers chapter summaries, appendices and a glossary.

Editorial Reviews

Review

"Wall Street's equivalent of the movie Nightmare on Elm Street - Part 10. Portfolio insurance / dynamic hedging, the Freddy Krueger of the 1987 stock market crash, is back again with the recent growth of options and swaps. Jacobs builds the case for how portfolio insurance and dynamic hedging exacerbated the 1987 crash and points out that dynamic hedging has played a similar role in recent periods of market volatility." Robert Glauber, Executive Director, Brady Commission and former Under Secretary of the Treasury <!--end-->

"Bruce Jacobs, an investment manager who predicted before the 1987 crash that portfolio insurance would trigger chain-reaction selling, recently forecast that option-strategies ('the sons of portfolio insurance') would play a similar, though more muted, role in a future debacle. Monday [October 27, 1997] provided damning evidence." The Wall Street Journal

"Every fiduciary should read this book. Investors have too often been taken in by promotions appealing to their basic human instincts of fear and greed. Bruce Jacobs shows how supposedly low-risk, seemingly infallible, investment strategies can backfire. His views on portfolio insurance helped steer our profit-sharing fund away from that craze in 1987. Today, especially in light of the long-term Capital Management fiasco, investors should know what Bruce has to say about derivatives trading strategies and market crashes." John E. Stettler, Vice President - Benefit Investments, Georgia-Pacific Corporation

"Bruce Jacobs demonstrates effectively that trend-following strategies like portfolio insurance are fair-weather techniques that may add to, rather than minimize, troubles when a major crash occurs." Charles P. Kindleberger, author of Manias, Panics, and Crashes: A History of Financial Crisis

"Bruce Jacobs has created an instant classic. Capital Ideas and Market Realities demonstrates how products that appeal to investors' fears of short-term losses often ignore prudence and long-term value. This book is a must read for every investor." The Journal of Investing

Book Description

This title warns investors, whether amateur or professional, of the need for caution in today's volatile markets. This extensively researched work sifts through the history of modern finance from the Efficient Market Hypothesis to behavioral psychology & chaos theory in order to identify the cause of recent market crashes.

See all Editorial Reviews

Product Details

• Paperback: 432 pages
• Publisher: Wiley-Blackwell; 1 edition (August 11, 1999)
• Language: English
• ISBN-10: 0631215557
• ISBN-13: 978-0631215554
• Product Dimensions: 9 x 6 x 0.9 inches
• Shipping Weight: 1.3 pounds (View shipping rates and policies)
• Average Customer Review: 3.2 out of 5 stars  See all reviews (4 customer reviews)
• Amazon Best Sellers Rank: #2,280,922 in Books (See Top 100 in Books)

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Customer Reviews

Most Helpful Customer Reviews

33 of 39 people found the following review helpful:

5.0 out of 5 stars A Fascinating Work about Today's Financial Alchemy, July 11, 2000

By A Customer

This review is from: Capital Ideas and Market Realities: Option Replication, Investor Behavior, and Stock Market Crashes (Paperback)

he book provides an extremely enlightening treatment of arcane financial strategies that have derived from Nobel Laureate winning option pricing theory. It is a well-written description of how very smart people are able to "outwit" other supposed very smart people by promising something for nothing. There will always be those who will dream up complicated strategies that purport to promise high return for low risk and thus demand a premium for providing their strategy. The book reminded me of Albert Einstein's work for the Swiss Patent Office at the turn of the century. He would daily receive applications for new and different perpetual motion ideas. Sometimes the ideas were so complicated Einstein could not readily find their flaw. (Finally, he encouraged the patent office to pass a ruling stating that anyone wishing to patent something which broke the second law of thermodynamics had to submit an actual working unit.)

Portfolio insurance was the first large scale application of option pricing theory. Long-Term Capital Management, a highly leveraged hedge fund partnered by the Nobelists, was the second large scale application. Both promised free lunches. It is easy for the disciplined, long-term, individual investor to look at the 1987 crash and the LTCM debacle and conclude that it doesn't matter. The ones who were harmed the most were the purveyors of these supposed perpetual motion machines as well as the investors who "played with this fire". In fact, however, Jacobs' book is a wake-up call that these new financial strategies have become so far reaching, that they can have significant impact not only on the financial markets, but on the global economy as well. The missing element in the book is a way for regulators to rein in an industry that is out of control and return it to its basic purpose: moving money from people that have it (investors) to people that need it and educating the investor on the risk/reward tradeoffs. The industry subrole of shifting risk from people who cannot accept it (e.g. farmers) to those who can (speculators) is also valid, however, it has become so pervasive and sophisticated that it begs for a return to sanity. Absent that, Jacobs' book is an eye-opener, and a must read for anyone hoping to cope with today's complicated markets.

35 of 47 people found the following review helpful:

1.0 out of 5 stars Disappointing!, May 1, 2000

By 

Professor Joseph L. McCauley "Joseph L. McCauley" (Austria+Texas) - See all my reviews

Amazon Verified Purchase

This review is from: Capital Ideas and Market Realities: Option Replication, Investor Behavior, and Stock Market Crashes (Paperback)

After reading Bernstein's Capital Ideas, a cheerleading book for lognormal finance theory, which gushes over heroes, I had high expectations for Jacobs' criticism Bernstein's viewpoint. But Jacobs' sole argument seems to be that portfolio insurance was a bad idea, and he repeats it too often. Many chapters are simply too repetitive and were written as if they'd been cut and pasted from different badly-written review articles. Even though the book is post-LTCM (post 10/98) most of the book is taken by with attacking of LOR's pre-1987 idea of portfolio insurance, while the far more fascinating and more recent case of LTCM and the near collapse of the global finance system is hardly discussed. I recommend instead "The Vandal's Crown" and "Inventing Money".

10 of 15 people found the following review helpful:

5.0 out of 5 stars A Fascinating Work about Today's Financial Alchemy, June 6, 2000

By A Customer

This review is from: Capital Ideas and Market Realities: Option Replication, Investor Behavior, and Stock Market Crashes (Paperback)

The book provides an extremely enlightening treatment of arcane financial strategies that have derived from Nobel Laureate winning option pricing theory. It is a well-written description of how very smart people are able to "outwit" other supposed very smart people by promising something for nothing. There will always be those who will dream up complicated strategies that purport to promise high return for low risk and thus demand a premium for providing their strategy. The book reminded me of Albert Einstein's work for the Swiss Patent Office at the turn of the century. He would daily receive applications for new and different perpetual motion ideas. Sometimes the ideas were so complicated Einstein could not readily find their flaw. (Finally, he encouraged the patent office to pass a ruling stating that anyone wishing to patent something which broke the second law of thermodynamics had to submit an actual working unit.) Portfolio insurance was the first large scale application of option pricing theory. Long-Term Capital Management, a highly leveraged hedge fund partnered by the Nobelists, was the second large scale application. Both promised free lunches. It is easy for the disciplined, long-term, individual investor to look at the 1987 crash and the LTCM debacle and conclude that it doesn't matter. The ones who were harmed the most were the purveyors of these supposed perpetual motion machines as well as the investors who "played with this fire". In fact, however, Jacobs' book is a wake-up call that these new financial strategies have become so far reaching, that they can have significant impact not only on the financial markets, but on the global economy as well. The missing element in the book is a way for regulators to rein in an industry that is out of control and return it to its basic purpose: moving money from people that have it (investors) to people that need it and educating the investor on the risk/reward tradeoffs. The industry subrole of shifting risk from people who cannot accept it (e.g. farmers) to those who can (speculators) is also valid, however, it has become so pervasive and sophisticated that it begs for a return to sanity. Absent that, Jacobs' book is an eye-opener, and a must read for anyone hoping to cope with today's complicated markets.