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THEORY AND REALITY IN FINANCIAL ECONOMICS Essays Toward A NewPolitical Finance 6502tp.indd 1/31/08 10:08:32 AM This page intentionally left blank THEORY AND REALITY IN FINANCIAL ECONOMICS Essays Toward A NewPolitical Finance George M Frankfurter ProfessorEmeritus, Louisiana State University, USA World Scientific NEW JERSEY LONDON SINGAPORE BEIJING SHANGHAI HONG KONG TAIPEI CHENNAI 6502tp.indd 1/31/08 10:08:34 AM Published by World Scientific Publishing Co Pte Ltd Toh Tuck Link, Singapore 596224 USA office: 27 Warren Street, Suite 401-402, Hackensack, NJ 07601 UK office: 57 Shelton Street, Covent Garden, London WC2H 9HE Library of Congress Cataloging-in-Publication Data Frankfurter, George M Theory and reality in financial economics : essays toward a new political finance / by George M Frankfurter p cm Includes bibliographical references and index ISBN-13: 978-981-270-791-8 ISBN-10: 981-270-791-3 Finance Economics I Title HG173.F688 2007 332.01 dc22 2007033434 British Library Cataloguing-in-Publication Data A catalogue record for this book is available from the British Library Copyright © 2007 by World Scientific Publishing Co Pte Ltd All rights reserved This book, or parts thereof, may not be reproduced in any form or by any means, electronic or mechanical, including photocopying, recording or any information storage and retrieval system now known or to be invented, without written permission from the Publisher For photocopying of material in this volume, please pay a copying fee through the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, USA In this case permission to photocopy is not required from the publisher Typeset by Stallion Press Email: enquiries@stallionpress.com Printed in Singapore Yvonne - Theory and Reality.pmd 2/14/2008, 3:01 PM B519_FM.qxd 9/21/2007 10:29 AM Page v FA Foreword It is quite unusual to see the words “theory” and “reality” together in the title of a book on financial economics It is even more unusual to see the word “political” in its subtitle For most finance professors, reality is something you use to test your theories, but the theories themselves are deliberately unrealistic And if the theories are not consistent with reality, the blame falls on reality and not on the theories Politics is something that impedes the efficient functioning of markets, which, if left to their own devices, will deliver the greatest good to the greatest number of people George Frankfurter is uniquely qualified to challenge these conventional views His distinguished academic career has given him a thorough background in the theories that form the foundation of financial economics Unlike most of his professional colleagues, however, he has not hesitated to expose the cracks that would topple large parts of the structure were it not for a quasi-religious faith in the feats that rational economic men are capable of accomplishing when they are given free rein in free markets He has not been afraid to confront the academic publication and promotion system that ensures no one is allowed to question the real issues too closely George is one of the few financial economists who has a sufficiently broad perspective beyond the campus to see how this faith not only props up academic theories, but also sustains a form of elite capitalism that serves its masters and their political allies better than it serves the rest of us Any number of astonishing deceptions and disturbing inequities are excused as the inevitable consequences of a competitive market Since Microsoft has acquired an overwhelming dominance in the market for personal computer operating systems, it must be as a result of superior innovation and performance Since for-profit universities are successfully making money selling degrees, they must be the best means to create an educated and engaged citizenry Since Enron’s stock price was soaring, it must have represented the future of the nation’s energy management And if we couldn’t believe their auditors — the venerable Arthur Andersen — that all was well, then who could we believe? v B519_FM.qxd 9/21/2007 10:29 AM Page vi FA vi Theory and Reality in Financial Economics It seems so obvious, then, that if we want to ensure adequate medical care for everyone, insurance and healthcare companies will take care of it If we want to enhance the nation’s security through energy independence, oil companies will create the alternatives to imported petroleum If we want to eliminate poverty, there are small businesses desperate to hire the poor at the right wage Through the magic of free markets, everyone can make money and build a just and equitable society at the same time Not content to just expose what has gone wrong, George is able to suggest reforms to both the academic and the political-economic systems that might make markets truly efficient Fair, not just free, markets are capable of giving us greater wealth and freedom in many ways — not just the freedom to become wealthy by purchasing stock that we hope to sell to someone else for a higher price Professor Elton G McGoun William H Dunkak Professor of Finance Bucknell University B519_FM.qxd 9/21/2007 10:29 AM Page vii FA Prologue The animals that depend on instinct have an inherent knowledge of the laws of economics and of how to apply them; Man, with his powers of reason, has reduced economics to the level of a farce which is at once funnier and more tragic than Tobacco Road — James Thurber1 Political finance? As in “political economy”? Who in his right mind would conjure up such a thing? The short, barely six-decade history as an academic discipline of what is called finance that later distinctively changed to “financial economics” or “modern finance” has been ruled by Friedmaninan instrumentalism (Friedman, 1953) and neoclassical economic dogma Its elite vehemently argue that financial economics is value-neutral, ergo it is not and cannot be influenced by politics that is by definition ideology-laden If one subscribes to the notion that nothing that humans is valueneutral, but rather based on ideology, be it creed, religion, politics or selfpromotion, then one must consider financial economics’ claim to value-neutrality as a farce at best and disingenuous at worst Thus, modern finance2 just might be a ruse with which academic research (what can be thought of the ontology and epistemology of the field) masquerades as an imitation of the natural sciences Consequently, it is busy developing models and explanations — the more complex, the merrier — that fit compactly within the confines of equations and statistics, instead of dealing with economic realities that are suffused with politics This logic is to make sure that the movers and thinkers of academe will debate forever whether one paradigm or another can be supported by empirical evidence without the possibility of ever reaching a definite conclusion It also ensures that finance academics are not engaged in the The Columbia Dictionary of Quotations is licensed from Columbia University Press Copyright © 1993, 1995 by Columbia University Press All rights reserved I am using the term modern finance interchangeably with the term financial economics, as many of the practitioners of the latter argue that the two are one and the same vii B519_FM.qxd 9/21/2007 10:29 AM Page viii FA viii Theory and Reality in Financial Economics process of discovery, the ultimate goal of science, because such process might bring an end to the ideology that rules the field This is why, for instance, academics in the finance discipline have been pondering close to 40 years the question of whether markets are efficient, and if yes, then to what degree Informational market efficiency3 was enshrined in Fama’s efficient markets hypothesis (EMH) (Fama, 1965, 1970) as a quasi-religion and later was assigned three distinct forms: • the weak; • the semi-strong; and • the strong The consequence of the EMH is the perception that markets are omnipotent (de facto the avatar of God), and Pareto optimal So, anything that would replace them would be a deterrent to the welfare of some and possibly everyone without leaving anyone better off This notion, lately, found for itself several new euphemisms for the benefit of the common man, the most popular of which are “free markets,” “globalization,” “new/space age,” “the new world order,” etc Accordingly, everyone who sets out to interfere with the market, especially a government, is doing a disservice to any given society, and possibly to humankind as well Those who doubt my contention here that modern finance is ideologyladen are advised to read Frankfurter and McGoun (1999) If after doing so the reader is still convinced that financial economics is “pure science,” although there is no such thing even in the natural sciences, then this manuscript is to serve as an additional charge to the contrary I will argue, in the hope to convince the convincible skeptics,4 that the financial world which financial economics tries to understand, explain, forecast and fashion is infused with politics to the point where the boundaries between economics and politics are totally muddled Thus, finance as a discipline that is ideologically driven cannot possibly understand, explain, forecast and fashion this world There are two other qualifiers of efficiency: liquidity (how fast the market can find a buyer for an asset), and allocational (how well the market allocates capital where it does the best) However, here as almost everywhere else I am dealing with informational efficiency only: how well prices reflect value I learned that where beliefs are based on deep ideological convictions, no argument, fact or evidence would change the mind of those who, because of this deep ideological belief, will not accept anything inconsistent with their values B519_FM.qxd 9/21/2007 10:29 AM Page ix FA Prologue ix Not that it ever wanted to, either Fama (1998) argues that the EMH cannot even be criticized until or unless a better and more complete paradigm is proposed to replace it This is in complete contradiction of Karl Popper’s heeding that “the beginning of science is myths, and the criticism of myths.” For how can we come up with a better paradigm than the EMH if one cannot criticize the EMH without offering a better paradigm? One must also recall that the EMH is there because it was the first to arrive, and not because it unseated an inferior paradigm that preceded it To make my point, first, I let others speak for me An editorial of The Washington Post that appeared in late May 2002, titled “After ENRON”, has this to say: The past decade has been a strange, split-screen kind of period On your left screen there was America the superpower, which triumphed over communism, created a new realm called cyberspace and outpaced rivals in Europe and Japan On your right screen there was America the scandal power, plagued by an explosion in political money and insider lobbying and a decline of trust in government Throughout the 1990s, these two screens seemed separate But the Enron scandal, starring a firm that symbolized both America’s economic dynamism and its political cronyism, brought the screens together It showed how lobbying and campaign money can damage the economic system This is why the Enron scandal is so potent Its many tentacles are united by a sense that rich insiders are rigging the system at the expense of ordinary Americans Enron’s energy dealers ripped off California’s consumers and got away with this behavior because of Enron’s clout in Washington Wall Street’s analysts cynically promoted Enron’s stock to unsuspecting investors because they coveted fat investment-banking fees — and got away with this conflict of interest because lobbyists and campaign dollars kept the regulators soft Capitalism rightly rewards people who make life better by providing goods and services But when rewards are distributed according to insider influence, that is cronyism Accounting is where the economic costs of cronyism are potentially highest Since the 1970s, the accounting lobby has fought off regulation and squashed opposition to its consulting ambitions — despite the fact that those ambitions sometimes turned outside audits into insider shams As a result, corporate accounts have been distorted — in Enron’s case, spectacularly, and investors are hard-pressed to know which companies deserve their money Capitalism defeated communism partly because the apparatchiks directed savings to the wrong places When cronyism undermines the information that investors rely upon, it damages capitalism’s central nerve B519_Afterword.qxd 9/21/2007 10:26 AM Page 201 FA Afterword 201 me of not having Friedman’s religion “No Sir,” I replied, “we have the same religion We just don’t believe in the same things.” That Professor Friedman was an ideologue first and economist after is clear when one reads his collection of essays, published under the title Capitalism and Freedom (Friedman, 1962, 1982), in which he declares in so many possible ways that capitalism is a necessary condition of freedom, and ultimately, of democracy This is so, because, albeit some might argue that socialism and democracy can go hand-in-hand: The thesis [of this chapter] is that such a view is a delusion, that there is an intimate connection between economics and politics, that only certain combinations of political and economic arrangements are possible, and that in particular, a society which is socialist cannot also be democratic, in the sense of guaranteeing individual freedom (ibid., p 8) Another anthology of Friedman’s, titled “The Methodology of Positive Economics” (Friedman, 1953), gave a free hand to economists to concoct models and explanations to economic phenomena based on a dream world, because the assumptions on which economic theories rest are “necessarily wild,” (read, unrealistic) and what counts is their predictive ability “for the purpose at hand” which is the formulation of social policy The practitioners of positive economics vehemently deny, however, “that there is an intimate connection between economics and politics,” and argue that their theories are “value-neutral.” There is not a single leading economic model that takes into account the influence of money in politics, and nefarious deeds of firms and managers in order to “maximize shareholders’ wealth.” Friedman’s relentless pushing of laissez faire has been the foundation of the socio-economic policies of Nixon, Reagan, Bush, Sr., and, ultimately, Bush, Jr Although, truth be told, Jimmy Carter started the epidemic of deregulation which brought about the massive failings of the thrifts in 1989–1991 and the bankruptcies of major airlines as of late And let us not forget that Bill Clinton made NAFTA possible Nevertheless, Friedman was the way, the truth and life in and out of academia Yet, the political regimes that espoused the Friedmanian doctrine created the biggest government interventionism in the so-called free markets for the sake of destabilizing the ruble, an unheard of military buildup/ budget, staggering deficits to cut social spending, totally at variance with B519_Afterword.qxd 9/21/2007 10:26 AM Page 202 FA 202 Theory and Reality in Financial Economics the idea of getting the government’s dirty hands off the markets, domestic or otherwise The very same policies turned the SEC into a paper tiger, manufactured government incompetence to prove the point that government is bad, and left national healthcare, drug and energy policies under the influence of corporate giants Albeit a bit harsh, the words of Dresden James come to mind: “When a well-packed web of lies has been sold gradually to the masses over generations, the truth will seem utterly preposterous and its speaker a raving lunatic.” What Friedman brought about was Reaganomics in several different monikers133 that first and foremost resulted in a grossly disproportionate allocation of income, and ultimately wealth, since the Great Depression, certainly since “baby-booming.” How many high-paying industrial jobs left this country since 1980 when the Reagan revolution came to pass, destroying, de facto, the American labor movement? And how did it happen that after our steel industry collapsed into the dustbin of the rustbelts, the unemployed steelworkers who tried to retrain as computer programmers (at Mr Reagan’s suggestion, if it were possible) are now working for us in Calcutta via satellite? And how did “outsourcing,” a sexy-sounding euphemism for importing cheap labor, turn essential for our economy as per Mr George W Bush? What this ideology created was a Wal-Mart economy in which the majority can afford only the bare necessities of livelihood, and the real economic well-being of the masses should be measured by the number of outlets of Dollar General Stores where they live The academics who followed the Friedman tune did it because that was the way to fame and fortune In a market-based economy, science, or rather meta-science which is what economics is, follows the money interests That is why the corporate sponsors who underwrote the academic chairs were eager to see the laissez faire dogma ruling the “predictions” that are instrumental for social policy to keep the government out of their business Friedman and the neoclassicals must have been right, were they not? After all, their philosophy is based on Adam Smith, whose work is almost written in stone And Friedman’s laissez faire was Adam Smith’s idea, was it not? 133 The latest of which is “The Job Growth and Taxpayer Relief Reconciliation Act of 2003.” B519_Afterword.qxd 9/21/2007 10:26 AM Page 203 FA Afterword 203 The funny thing about Friedman and Adam Smith is that neoclassical economics’ battle cry was co-opted from the latter’s great work, The Wealth of Nations (Smith, 1937): It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest (Book I, p 11) Smith, a radical individualist, who was a humanist first, a philosopher second and an economist third, also wrote in his great work: Whenever the legislature attempts to regulate the differences between masters and workmen, its counselors are always the masters When regulation, therefore, is in favour of the workmen, it is always just and equitable; but it is sometimes otherwise when in favour of the masters (ibid., pp 112–113) I have never heard the neoclassical school quoting this passage from Adam Smith Moreover, the regimes of Mr Reagan and those that followed made sure that it was always “otherwise.” One must not forget that Smith’s worldview was based on the utopia of perfect competition and a bucolic co-existence between the entrepreneur and craftsmen working in harmony, one for all and all for one This is certainly not the world we live in With all fairness, I must admit that at least to the extent that economics and politics are strongly interconnected, Friedman was right on the button If I may say so, politics is just the sugar-coating, the correct speech, to swallow a bitter pill, otherwise the majority would not go for in a democracy That the coating eventually wears off showed up clearly in the 2006 mid-term elections The supreme fallacy of the Friedmanian dogma was his belief in capitalism as a necessary condition of freedom, and by transference, that democracy is not possible otherwise The last six years of erosion of our civil rights with PATRIOT I and II, wiretapping, military tribunals for suspected enemy combatants (Americans and foreigners) and Public Law 109-364 (practically overriding the insurrection and posse comitatus acts), giving the President the power to use the National Guard without the acquiescence of the governor of the state to control civil disobedience, brings us as close to Stalinism as one could ever come in a nightmare B519_Afterword.qxd 9/21/2007 10:26 AM Page 204 FA 204 Theory and Reality in Financial Economics Perhaps the ideology that Friedman mongered is not the capitalism he had in mind Can it be that American capitalism and the idea of world domination is Friedman’s bastard child? Or is what you have read so far just the incoherent rattling of an iconoclast? George M Frankfurter Lloyd F Collette Professor, Emeritus Louisiana State University References Friedman, M.M 1953 “The Methodology of Positive Economics.” In Essays in Positive Economics, edited by M.M Friedman Chicago: The University of Chicago Press ——— 1962, 1982 Capitalism and Freedom Chicago: The University of Chicago Press Smith, A 1937 The Wealth of Nations New York: Random House B519_Author Index.qxd 9/21/2007 10:30 AM Page 205 FA Author Index Carlin, George 163 Carter, Jimmy 201 Casabona, Patrick A 19 Causey, Richard 125 Cecchetti, Stephen G 19 Chaitin, Gregory J 16 Chen, Carl R 20 Cheney, Dick 41, 106, 110, 116, 117, 132, 160, 194 Cheng, Pao L 19, 21 Cialone, Joseph A 144 Clinton, Bill 201 Coase, R.H 16 Colander, David 49 Collison, Daniel 188 Condon, Richard 40, 131, 136 Conine, Jr., Thomas E 19 Connor, Gregory 20 Cooley, Philip L 83, 88 Corhay, Albert 20 Cox, Larry A 20 Crum, Roy L 19 Akerlof, George 60 Allais, Maurice 9, 58 Allen, Robert 103, 112 Bacanovic, Peter 141 Baker, James 122 Ball, Ray xi, 23 Banville, John 33 Bark, Hee-Kung K 19 Baudrillard, Jean 151, 172, 193 Beedles, William L 19 Benkato, Omar M 20 Berardino, Joseph 123–125 Best, Michael J 19 Bey, Roger P 19 Bhattacharya, Sudipto 154 Black, Fischer xii, 85, 154, 169 Blanchard, Olivier 56 Bleuler, Eugene 48 Bodurtha, Jr., James N 19 Bower, Dorothy H 19 Branch, Ben 19 Brigham, Eugene F 19 Brown, Philip 19 Brown, Stewart 19, 21 Bubnys, Edward L 19 Buffett, Warren 103 Buschena, David 10 Bush, Jr., George 112, 118, 142–146, 156, 201 Bush, Sr., George 111, 143, 146, 157, 201 de Saussure, Ferdinand 172, 178 DeBondt, Werner 39 Dick, Melvin 149 Dobbs, Lou 92, 123, 127, 160 Dreman, David 40 Duncan, David 125 Easterbrook, Frank H 14 Ebbers, Bernard J 42 205 B519_Author Index.qxd 9/21/2007 10:30 AM Page 206 FA 206 Theory and Reality in Financial Economics Fagan, Perry 103 Falwell 128 Fama, Eugene F viii, ix, 3, 10, 13, 18, 19, 23, 35, 36, 38, 40, 53–55, 73, 76, 81, 85, 87, 154, 169, 177–179, 194 Farhi, Paul 97, 98 Fastow, Andrew 110 Feingold–McGain 113, 137, 163 Fish, Stanley 193 Fitoussi, Jean-Paul 56, 57 Frankel, Jeffrey A 20 Frankfurter, George v, viii, 5, 8, 20, 24, 35, 52, 53, 55, 60, 77, 124, 153, 171, 175, 176, 178, 180, 183, 204 Freeman, David 195 French, Kenneth R 54 Friedman, Milton vii, xv, 4–7, 11–13, 15, 18, 39, 48, 49, 59, 152, 153, 160, 162, 165, 166, 169, 175, 177, 179, 193, 194, 199–204 Friend, Irwin 20 Galbraight, James 56 Galbraith, John Kenneth 37, 194, 200 Giuliani, Rudolph 43, 134 Gödel, Kurt 16 Goldberg, Michael A 20 Goldwater, Barry 199 Gombola, Michael J 20 Gore, Al 122 Graddy, Duane B 20 Grauer, Robert R 19, 20 Greenspan, Alan 122 Gruber, Martin 20 Grubman, Jack 139 Haddad, Mahmoud M 20 Halevi, Joseph 56 Harlow, W van 20 Harrington, Scott E 20 Harvey, Campbell R 20 Hecht, Eric 140, 141 Heck and Cooley (HC) 83–88 Holler, Manfred xiv, 24 Hollings, Fritz 106 Holloway, Natalee 163 Homaifar, Ghassem 20 Hoover, Herbert 122 Horgan, John 16 Hudson, M 157–159, 162 Jackson, Michael 163 James, Dresden 174, 202 Janick, Herbert F 144 Jensen, Michael C 20, 76, 85, 103, 154, 195 Jensen and Fagan (JF) 103–105 Johnson, Ken 141 Jordan, Bradford D 21 Jorion, Philippe 20 Jun, Kwang W 20 Kahl, Douglas R 20 Kahneman, Daniel 10, 24, 39, 60 Kanner, Leo 48 Keim, Donald B 20 Kendrik, Phil 143 Keynes, John Maynard 123, 200 Kirshner, Daniel 21 Klamer, Arjo 6, 49 Klemkosky, Robert C 20 Korajczyk, Robert A 20 Kozlowski, L Dennis 140 Kristol, Bill 121 B519_Author Index.qxd 9/21/2007 10:30 AM Page 207 FA Author Index 207 Kroll, Yoram 20 Krugman, Paul 121 Kudlow, Larry 121 Kuhn, Thomas S xi, 16, 170, 176 Lakonishok, Josef 20 Lang, Jack 49, 181 Lanser, Howard P 20 Lawson, Tony 57, 59, 177 Lay, Kenneth 107, 113 Lee, Jimmy 139 Leland, Johnatan W 10 Levhari, David 20 Levy, Haim 20, 21 Lieberman, Joseph 110, 134 Liebman, A.J 97 Lincoln, Abraham 183 Lindsey, Lawrence 121 Lintner, John xii, 154, 169 Litzenberger, Robert 21 Lloyd, William P 20 Long, Jr., John B 21 Luciano, Charles “Lucky” 137 Machlup, Fritz MacKinlay, A Craig 21 Maimonides, Moses 179 Malernee, James K 21 Mankiw, N Gregory 21 Mannheim, Karl Mark, Nelson C 19 Markey, Edward J 136 Markowitz, Harry M 9, 36, 79, 85, 86, 153, 169, 170, 176, 178 Marshall, William J 21 McBeth, James D 19 McEnally, Richard W 21 McGoun, Elton viii, xvi, 5, 24, 35, 52, 53, 55, 60, 81, 170–172, 175, 176, 178, 185 Mcintosh, Norman B 172, 173 Meckling, William H 85, 154, 195 Merton, Robert C 73, 85, 154 Milken, Michael 91, 137, 139 Mill, John Stuart 161 Miller, Merton H 3, 13, 85, 153, 176 Modigliani, Franco 3, 6, 13, 85, 153, 176, 200 Morgenstern, Oskar Mullins, Jr., David W 21 Murphy, J Austin 21 Nagorniak, John 21 Nelson 114, 124 Ng, Lilian 21 Nixon, Richard 117, 201 Nock, Albert Jay Oxley, Michael G 198 Peirce, Charles Sanders 172 Percival, John 21 Peseau, Dennis E 21 Peterson, David R 19 Pettway, Richard H 21 Pitt, Harvey 112 Polanyi, Livia 76 Popper, Karl ix, 16, 55, 85, 170 Poussin, Nicolas 33 Power, David 182, 188 Purcell, Philip J 8, 20, 198 Racicot, Marc 121 Rao, Ramesh 20 B519_Author Index.qxd 9/21/2007 10:30 AM Page 208 FA 208 Theory and Reality in Financial Economics Reagan, Ronald 156, 157, 201, 202, 203 Reagan–Bush 111, 119, 155, 156 Reed, Ralph 120, 121 Reinganum, Marc R 21 Reiter, Sara Ann 24, 74, 76, 77, 195 Rohatyn, Felix 39, 116, 138 Roll, Richard W 21, 76 Rosenberg, Barr 77 Ross, Stephen A 13, 21, 154 Rothstein, Edward 193, 194 Rubinstein, Ariel 10 Rudd, E Ann 20 Rusnak, John M 140 Safire, William 117 Sapir, Jacques 56 Sauer, Andreas 21 Schmalensee, Richard 21 Schneider, Scott 140 Scholes, Myron 85, 154 Schumpeter, Joseph Schwert, G William 21 Scott, Elton 21 Scubik, Tatjana 24 Seguin, Paul J 21 Shanken, Jay 21 Shapiro, Alan C 20 Shapiro, Matthew D 21 Sharpe, William F xii, 9, 12, 13, 21, 38, 85, 154, 169, 170, 177, 179 Shorr, Daniel 105 Shukla, Raviv 21 Smith, Adam 6, 100, 118, 202, 203 Smith, Vernon 60 Soley, Lawrence xi, 7, 59, 91–93 Solow, Robert 56 Spence, Michael 60, 85 Spitzer, Eliot L 43, 44, 134–137 Stambaugh, Robert F 21 Starr, Kenneth 112 Stewart, Martha 132, 141, 142 Stiglitz, Joseph 60 Stoll, Hans R 21 Strassmann, Diana L 76, 77 Strauss, Leo 179 Stulz, Rene M 15 Sullivan, Scott 42, 133, 149 Summers, Lawrence 108 Swamy 77 Swidler, Steve 21 Szostak, R 166 Tamarkin, Maurry 19 Tauzin, Billy 134, 141 Thaler, Richard 39, 54 Tow, Leonard 140 Trzcinka, Charles 21 Turnbull, Stuart M 21 Tversky, Amos 10, 24, 39 Udinsky, Jerald H 21 Upton, David E 21 Vandell, Robert F 21 Veblen, Thorstein 156 Volker, Paul A xv, 123, 125–128, 134 Von Neumann, John Von Neumann and Morgenstern (VM) 8–10 Vora, Ashok 19, 20 Waksal, Samuel 141 Walsh, Frank E 140 Watson, E Stuart 146 Watts, Ross L 21 Weld, William 91 B519_Author Index.qxd 9/21/2007 10:30 AM Page 209 FA Author Index 209 Westerfield, Randolph 20 Whittle, Chris 91 Winnick, Gary 138 Wittgenstein, Ludwig 16, 44 Wu, Chunchi 20 Wyatt, Edward 91, 94 Yawitz, Jess B 21 Zepp, Thomas M 21 Zhou, Guofu 20, 21 Zilberman, David 10 Zoellick, Robert 121 B519_Author Index.qxd 9/21/2007 10:30 AM Page 210 FA This page intentionally left blank B519_Subject Index.qxd 9/21/2007 10:32 AM Page 211 FA Subject Index Bank of America 140 behavioral finance 3, 10, 23, 24, 39, 40, 45, 53, 54, 55, 81, 87, 179, 200 Bretton Woods Conference 200 Bristol-Myers Squibb Co 141 Brownian motion 16, 37 Bush Administration 156 Adelphia 41, 132, 140 agency theory 14, 15, 78, 85, 87, 154, 195, 196 Allais paradox 9, 10 Allfirst Financial 140 Allied Irish Banks 140 allocational viii, 35 Aloha Petroleum 143, 144 American capitalism 115, 138, 142, 146, 165, 196, 204 anomalies literature xi, 3, 24, 40, 54, 81, 87, 179 anomaly xi, xii, xvi, 3, 7, 10, 19–21, 24, 25, 39, 40, 54, 81, 87, 179, 194 arbitrage 13, 86 arbitrage mechanism xi arbitrage opportunities 13 Arbitrage Pricing Theory (APT) 13, 19, 21, 86, 154 arbitrageurs 13 Arbusto 142 Arthur Andersen LLP v, xiv, xv, 41, 42, 103, 105, 108, 123–126, 128, 132, 133, 134, 149 assumptions 4, 5, 7, 9, 11, 12, 13, 15, 18, 35, 38, 44, 48, 49, 54, 74, 75, 76, 77, 81, 85, 175, 177, 183, 186, 201 autistic finance xii, 47, 59 autistic science 47, 180 axioms 4, 7, 8, 9, 10, 11, 15, 16, 35, 44, 77, 183, 184, 187 capital viii, xiii, xv, 14, 15, 18, 19, 20, 21, 35, 42, 86, 133, 139, 143, 154, 157, 158, 159, 161, 163, 183, 185, 187, 195 Capital Asset Pricing Model (CAPM) xii, 19, 20, 21, 38, 39, 85, 154, 169, 170, 177, 179 capital budgeting 15 capital structure 14, 15, 85, 86 capitalism v, ix–xi, xv, 5, 15, 37, 93, 103, 106, 111, 112, 114, 115, 123, 136, 137, 138, 142, 146, 151, 152, 153, 154, 165, 166, 174, 183, 185, 194, 196, 197, 200, 201, 203, 204 capitalism and freedom 152, 166, 201 Century Communications 140 Chicago–Rochester School 7, 194 Citibank 140 Claritin 147 Clinton Administration 156 cointegrations 77 Cold War 33, 152, 156, 199, 200 Comcast 112 contingent claims 154 211 B519_Subject Index.qxd 9/21/2007 10:32 AM Page 212 FA 212 Theory and Reality in Financial Economics contrarian literature 200 contrarians 40 cost of capital 14, 15, 20, 21, 86 Cox Communications 112 data snooping 14 democracy xv, 152, 153, 165, 185, 201, 203 discovery viii, xiii, 23, 36, 55, 64, 88, 170, 179 dividend behavior 60 dividend policy 14, 86, 89 dividend signaling 17 dividends 14, 21, 85, 86 downsizing xiv, 94, 105, 108, 186, 187 Drexel Burnham Lambert 139 efficiency viii, xi–xiii, 21, 23, 33, 34–39, 44, 45, 54, 59, 70, 86, 89, 92–94, 111–114, 161, 171, 178, 179, 185, 187, 194, 196, 200 efficient markets xiv, 13, 18, 41, 55, 59, 85, 112, 114, 169, 171, 194, 195 Efficient Markets Hypotheses (EMH) viii, ix, xi, xii, 23, 35, 38, 39, 40, 54, 76, 154, 169, 175, 177, 178, 179 EMH/CAPM 10, 18, 53, 81, 170 Energy and Commerce Committee 141 Enron v, ix, x, xiii, xiv, xv, 40, 41–43, 103, 105–113, 115, 116, 117, 118, 120, 121, 122, 124, 125, 128, 132, 134, 135, 136, 146, 149, 194, 195, 196 Enronism 194 enronomics 43, 116, 122, 134 epistemology vii, 3, 22, 35, 87, 173 equilibrium 9, 12, 13, 19, 35, 64, 169, 177 Erbitux 140, 141 ESOP 41, 110, 114 event study 10, 13, 17, 18, 58, 70, 77, 179 event study methodology 179 Expected Utility Maxim (EUM) 9, 39 fair markets xiv, xvi, 114, 153, 169, 171, 186, 187 fairness 12, 74, 114, 153, 185, 187, 188, 203 FDA 140, 141 Federal Reserve xv, 123, 127, 157 financial economics v, vii, viii, xii, xiii, 3, 4–14, 22–25, 35–37, 48, 49, 52–55, 57, 59, 60, 75, 76, 78, 85, 115, 153, 169, 171, 174–176, 179, 193, 194 financial economics/modern finance xii, 59, 175 free markets v, vi, viii, xiv, 5, 37, 41, 91, 93–95, 104, 112, 121, 122, 124, 132, 147–149, 194, 201 free-marketism xv, 141 Friedmanian doctrine 13, 18, 200, 201 Friedmanian positivism 59, 193 Friedmanian positivism/ instrumentalism 39 frontier of efficiency 36 GE 41, 132, 157 Global Crossing 41, 132, 138, 139, 143 globalization viii, xv, 37, 52, 104, 118, 157, 174, 183, 196 Gödel’s theorem 16 Great Depression 160, 200, 202 Guantanamo Bay 113 B519_Subject Index.qxd 9/21/2007 10:32 AM Page 213 FA Subject Index 213 laissez faire 152, 169, 176, 183, 187, 193, 199, 200, 201, 202 Le Movement Autisme Économie 47, 180 liquidity viii, 35 metafinance 88 method xii, 1, 2, 10, 15, 36, 76, 77, 81, 88, 176, 177, 179, 194 methodological construct 23 methodology xii, xiii, 1–5, 7, 10, 12–14, 19, 23, 24, 48, 52, 53, 54, 55, 56, 57, 59, 76, 81, 87, 169, 170, 173, 175, 179, 182, 194, 201 methodology of financial economics xii, 3, 5, 55 methodology of positive economics 5, 169, 170, 175, 201 methodology ziggurat methods of analysis 23 Microsoft v, xiii, 1, 42, 97, 98, 99, 100, 101, 109, 132 micro-structure 85 model 4, 5, 9, 11, 12, 13, 15, 17, 18, 19, 20, 21, 38, 39, 41, 55, 58, 64, 72, 85, 107, 137, 153, 154, 163, 169, 170, 176, 177, 178, 193, 194, 201 modern finance vii, viii, xi, xii, 3, 12, 16, 17, 18, 22, 24, 35, 48, 49, 53, 54, 55, 57, 59, 86, 153, 154, 171, 173, 175, 176, 193, 194, 195 modern finance’s methods 22 modern financial theory 171 modernism 17, 193 modernity 176, 178 Morgan Chase 139 Morgan Stanley 198 market efficiency xi, xii, xiii, 23, 34, 35, 36, 37, 38, 39, 44, 45, 54, 86, 112, 113, 171, 179, 187, 194, 200 McCain/Feingold Bill 137 Merrill Lynch 43, 122, 134–136, 140, 141, 146 NAFTA 157, 187, 201 National Association of Securities Dealers 112 neoclassical economics xii, xiv, 6, 50, 59, 111, 152, 182, 203 neoclassical methodology 52 Halliburton 41, 132, 194 Harken Energy 142, 143 HealthSouth 41 Helmut Kohl affair 137 Home.com xiv, 112 homo economicus 193 House Financial Services Committee 149 hyperreality 172, 173, 175 ideology vii, viii, xii, xiii, xiv, 4–7, 14–16, 23, 34, 35, 36, 55, 60, 70, 74, 97, 114, 152, 169, 170, 176, 178, 183, 185, 194, 199, 202, 204 ideology/religion 23 ImClone 140, 141 informational efficiency viii, 37 informationally efficient markets 13, 18, 194 instrumentalist methodology International Standards of Accounting (IAS) 197 Kanner syndrome 48 Kansas City Proposal (KCP) 51, 52, 180, 182 B519_Subject Index.qxd 9/21/2007 10:32 AM Page 214 FA 214 Theory and Reality in Financial Economics neoclassical microeconomics 56 neoclassical opinion 57 neoclassical orthodoxy 52 neoclassical school 199, 200, 203 neoclassical theory 47, 180 neoclassicism 11, 50, 56, 57, 60, 112, 173, 180 net present value 15 new age xv, 41, 91, 93, 104, 110, 118, 194 new world order viii, xv, 37, 52, 56, 104, 118, 174, 200 new/space age viii, 37 normative 4, 9, 12, 14, 64, 66, 86, 89, 169, 170, 176, 178 normative portfolio theory 66, 170 normative theory 86, 89 ontology vii, 3, 7, 14, 15, 35, 87, 173 option pricing 85, 154 outsourcing 157, 162, 202 ownership class 163 Pacific Capital Group 139 Pareto optimality viii, 36, 154, 176, 185, 194 Parisian letters 152 Pavlov’s dog 152 pluralism 47, 57, 60, 180, 190 Popperian philosophy 14 positivism 39, 59, 193 positivist methodology 12, 48 Post-Autistic Economics (PAE) xii, xiii, 49, 180, 181 postmodern 194, 195 postmodernity 172, 193, 194 process of discovery viii, 23, 36, 170 Prospect Theory (PT) 10, 24, 39 quadratic utility 36 Reagan Administration 156 Reaganomics 202 realism 12, 59, 177 regret theory 10 religion of free markets (RFM) 124, 128 risk xiv, 9, 10, 17, 19, 20, 21, 36, 45, 52, 60, 72, 79, 95, 107, 110, 111, 114, 116, 120, 142, 158, 164, 177, 186 Salomon Smith Barney 139 Sarbanes x, 44, 149 Schering Plough 146, 147 Securities and Exchange Commission (SEC) 40, 42, 43, 45, 112, 131, 133, 134, 136, 137, 140, 143, 144, 145, 146, 147, 149, 198, 202 semiotics 172, 173, 174 semi-strong viii, 37, 38, 111 semi-strong form of efficiency 111 signaling 17, 85, 154 similarity maxim 10 socialism 104, 153, 201 Spectrum 142 Stalinism xv, 203 stochastic dominance 9, 36, 86 Stock Appreciation Rights (SAR) 114 stock options 103, 110, 114, 186 strong vii, x, xi, 37, 38, 66, 80, 111, 121, 154, 166, 175, 200 strong form of efficiency 38, 111 Theory of Fair Markets (TFM) xvi, 153, 169, 171, 180, 182, 183 B519_Subject Index.qxd 9/21/2007 10:32 AM Page 215 FA Subject Index The Red Lilly 152 The Spirit of the Laws 152 theory v, xii, xvi, 4, 5, 8, 9, 10, 11, 12, 13, 14, 15, 17, 18, 25, 35, 37, 38, 39, 40, 44, 47, 48, 49, 52, 54, 66, 76, 78, 85, 86, 87, 89, 112, 120, 125, 153, 154, 158, 169, 170, 171, 174, 175, 176, 177, 180, 187, 195, 196, 200 Tyco 42, 113, 132, 140 uncertain uncertainty 10 uncertainty 10, 47, 180 215 underreaction 10, 39, 40, 54 underreaction hypotheses 10 valuation 14, 21 value-neutrality vii, 4, 5, 6, 35, 201 Wal-Mart economy 202 weak viii, xiv, 37, 38, 127 welfare state 183 WorldCom 42, 132, 133, 143, 149, 173 Xerox 42, 133, 134