Thursday, September 2, 2010

More Recent Financial Breakthroughts are Quantitative rather than Regulatory

Furthermore, when I reviewed the breakthroughs in the financial markets, the more recent breakthroughs are quantitative rather than regulatory. For example, the regulation of the U.S. financial markets was shaped over 70 years ago by the Securities Act of 1933 and the Securities Exchange Act of 1934. Thesewere followed by the Investment Company Act of 1940 and the Investment Advisers Act of 1940—more than 60 years ago.

Conversely, consider all of the economic models that have been developed in the last 40 years: the Capital Asset Pricing Model of Sharpe (1964), Lintner (1965) and Mossin (1966) shaped how assets are valued. The Black-Scholes Option pricing model of 1973 and Merton’s Rational Theory of Option Pricing in the same year forever shaped how derivative markets are priced. And there are many other models that have been developed in the last 30 years: Ross’s Arbitrage pricing model of 1976, the Fama and French factor models of the 1990s, Grinold and Kahn’s Fundamental Law of Active Management in 1989 and its subsequent refinement in 2002 (for transfer coefficients), and the Black-Litterman model of 1990 for asset allocation. The economics of the financial markets are still being discovered and defined, and it is the quants who are leading the way.

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