The origins of mathematical finance

[bigbadwolf]

An essay on the origins of quant finance can be found here:

[FONT=Verdana, Arial, Helvetica, sans-serif][SIZE=-1]

... As I told my reader, whether this was the first time that betting on the market price was outlawed I am not sure. But as a historian of economic thought, and as one who has been interested in the market mechanism in the early stages of development of capitalism, I know that hedging and gambling in the market place are old practices, at least as old as the "commercial revolution" or the development of "merchant capitalism" in the 13th century. Indeed, as I have argued in my book, Money and Exchange: Folktales and Reality, and in some other essays, in medieval trade merchants regularly tried to cheat one another in the market place. [3] In so doing they used other merchants' ignorance of arithmetic to swindle them. Arithmetic—which at the time consisted mostly of knowledge of the Arab numerals, four basic mathematical operations and the "golden rule," or the "rule of three," where a missing fourth number in two equal ratios is found—had just reached Europe by way of Arab merchants. Between the 13th and 16th centuries a group of merchants in Europe, particularly in Italy, wrote manuscripts to teach merchants' children, who attended special training schools, the newly received arithmetic. But what is perhaps most interesting about these manuscripts is that almost all of them teach how to use arithmetic, particularly in the act of barter, to cheat their trading opponents and increase what they called the "overprice." As such, these medieval manuscripts taught that the rule of exchange was to come out ahead in transaction and that barter was "nothing but giving a good for another in order to get more."[/SIZE][/FONT]
[FONT=Verdana, Arial, Helvetica, sans-serif][SIZE=-1]
[/SIZE][/FONT]
[FONT=Verdana, Arial, Helvetica, sans-serif][SIZE=-1]To make a long story short, in the medieval markets arithmetic became a tool, a "financial innovation" to use the language of the modern market, to make more money. The rule of the game was to take advantage of arithmetical ignorance of others to gain as much profit as possible. This was how capitalism was born. It was born not of honesty, equality, justice or fairness in exchange, but of deceit, swindle, inequality, injustice and unfairness. It was also in this same period that one can find the emergence of many other financial innovations, such as forward contracts and bills of exchange, innovations that tried to increase profit by reducing uncertainty and risk.

[/SIZE][/FONT]


[FONT=Verdana, Arial, Helvetica, sans-serif][SIZE=-1]Keep this in mind the next time some jackass of a professor is droning on about risk-neutral measures and sigma-algebras.
[/SIZE][/FONT]

 

[bigbadwolf]

This Sasan Fayazmanesh writes insightfully, or rather he lucidly points out our lack of coherent insight concerning the economy. An excerpt from a different essay here:

[FONT=Verdana, Arial, Helvetica, sans-serif][SIZE=-1]

While each of these “causal” explanations, or a combination of them, might have some merit and need to be explored further, they are mostly after-the-fact explanations. None of the economists who are popping up in the media today explaining what caused the economic woes of 2008 was able to forecast the crisis a year or two earlier.

[/SIZE][/FONT]

[FONT=Verdana, Arial, Helvetica, sans-serif][SIZE=-1]Financial panics and severe economic downturns are nothing new in a capitalist economy. The history of this economic system, since at least the age of classical political economy, shows that monetary crises and “gluts” occur relatively frequently. This is expected. An economy in which goods are produced not for use but for profit is bound to have gluts now and then. Moreover, in an economic system where acquisitive behavior is considered to be virtuous and greed is said to be good one should expect the relentless creation of new and exotic financial instruments by those on the Wall Street—and, prior to that, on Lombard Street—to swindle one another. One should also expect to see the persistent and ingenious attempts by the money-lenders and the industrialists to prevent new regulations and circumvent the existing ones. Furthermore, in an economy where the livelihood of the masses depends on the whims and wishes of captains of the industry or the financiers, one should expect the masses to be called upon to “bailout” the same tycoons when they are pinched. Such measures, as President Bush said in his October 14, 2008, discussion of the economy, are “not intended to take over the free market, but to preserve it.” These are all expected. What is not expected is our ability to predict exactly when this slumbering beast wakes up, shakes off and lashes out. We do not have the theoretical edifice to allow such forecasting. Those who with great confidence explain the causes of the current crises, as well as those who, post mortem, explained with remarkable certainty the causes of the Great Depression, are probably the ones who least understand the nature of the beast.[/SIZE][/FONT]