4. A Brief History of Financial Economics for Actuaries

This chapter gives an historical overview of the emergence of some of the key ideas in financial economics (the branch of economics concerned with fields such as securities pricing, portfolio theory, corporate financial and investment theory and the behaviour of financial markets). Financial economics was not developed by actuaries. You may well ask why it is included in a history of actuarial thought. The answer is that, rather like probability and statistics, once its foundations had been developed, its ideas had important practical application in the world that actuaries occupied. As these ideas emerged, the actuarial profession had to determine how to incorporate the new insights provided by financial economics into its thinking and practices (and, indeed, where theory did not translate into practice). This was not an easy process, as these insights were often incongruent with the traditional actuarial perspective. It triggered great actuarial debate: was this incongruence merely a result of the theoretical and unworldly nature of the economic studies, or did it signal that some key areas of actuarial thought needed fundamental revision? This process is arguably still underway. It is one of the more interesting and fundamental aspects of the historical development of actuarial thought in the second half of the twentieth century. To really appreciate it, we need to understand something of the ideas of financial economics and how they originally developed, and this is the object of this part of the book.