Applications

Jacob Marschak proposed a simple translation between finance and economics. If financial variables can be described by their mean and variance, then, under certain assumptions, these measures can be directly incorporated into measures of utility and hence act to motivate the financial choices of human decision-makers. Marschak knew that such a simplification would permit a much more tractable approach to the decision sciences, just as the mean and variance approach allowed many physical processes to be described by the laws of thermodynamics. Certainly, higher order terms beyond the first and second moments on both the finance side and the utility side can be important in some circumstances. However, the mean and variance is relevant in all circumstances.