Modern Finance, Methodology and the Global Crisis
AbstractModern finance has a conceptually unified theoretical core that includes the efficient market hypothesis (EMH), the relationship between risk and return based on the Capital Asset Pricing Model (CAPM), the Modigliani-Miller theorems (M&M) and the Black-Scholes-Merton approach to option pricing. The core has been instrumental to the growth of the financial services industry, financial innovation, globalization, and deregulation. The significant impact of the core is explained by their success in elevating finance to the category of a science by extracting the acquisitiveness associated with economic freedom from the workings of a free market society. This success was somewhat of a paradox. The core theories/theorems were based on wildly unrealistic assumptions and did not stand out for their empirical strength. Overcoming this paradox required a methodological twist whereby theories were devised to create rather than to interpret or predict reality. This view led to a series of financial practices that increased the fragility and vulnerability of financial institutions setting the context for the occurrence of financial crises including the current one.
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Bibliographic InfoPaper provided by University of Utah, Department of Economics in its series Working Paper Series, Department of Economics, University of Utah with number 2010_04.
Length: 16 pages
Date of creation: 2010
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History of Finance; Economic Methodology;
Find related papers by JEL classification:
- B23 - Schools of Economic Thought and Methodology - - History of Economic Thought since 1925 - - - Econometrics; Quantitative and Mathematical Studies
- B41 - Schools of Economic Thought and Methodology - - Economic Methodology - - - Economic Methodology
This paper has been announced in the following NEP Reports:
- NEP-ALL-2010-04-11 (All new papers)
- NEP-CFN-2010-04-11 (Corporate Finance)
- NEP-HIS-2010-04-11 (Business, Economic & Financial History)
- NEP-RMG-2010-04-11 (Risk Management)
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