Heterodox Investment Theory (eBook)

Thomas Pistorius, PhD, holds a Masters degree in finance from Tilburg University and a Bachelor in philosophy from Utrecht University, Netherlands. He has spent his professional life working in investment management as an investment advisor, analyst, risk manager, and researcher. His research is driven by an interest in finance and the arts, encompassing the rhetoric, history, philosophy, and culture of investment theory to discuss stochastic predictability.

Heterodox Investment Theory 3
Acknowledgements 6
Contents 8
List of Figures 11
1 Introduction 12
1.1 The Critical Thinking of the Humanities 12
1.2 The Assumption of Predictability 13
The Assumption of Predictability 13
The Problem with Prediction in Investment Theory 15
1.3 The Relevance of the Assumption of Predictability 16
The Relevance for Academia 16
The Relevance for Society 17
The Relevance for the Financial Services Industry, Regulators, and Policymakers 19
1.4 The Purpose of the Investigation 20
1.5 The Forms of Predictability and Their Denial 22
The Forms of Predictability 22
Profitable versus Unprofitable Predictability 24
The Case for Deterministic Unpredictability in Economics 25
1.6 The History of Investment Theory and Its Alternatives 28
1.7 The Theories of Probability and Uncertainty 29
1.8 The Rhetoric of Economics 30
1.9 The Culture of Investing 33
Works Cited 34
2 The History of Investment Theory 38
2.1 An Introduction to the History of Investment Theory 38
History Enriches 38
The Pitfalls of History 41
The Assumption of (Un-)Predictability 44
2.2 Finance in Europe in the Thirteenth to Eighteenth Century 45
2.3 Efficient Market Theorists in the Nineteenth and Early Twentieth Centuries 49
Jules Regnault and Henri Lefèvre 49
Louis Bachelier 51
2.4 Finance in the First Half of the Twentieth Century 54
Irving Fisher 54
John Maynard Keynes 55
Benjamin Graham and John Burr Williams 57
Empirical Work on Predictability and the Random Walk 59
Chartist Theory 61
2.5 Markowitz’s Investment Theory 62
Portfolio Theory 62
Evaluation of Markowitz’s Contribution 65
2.6 Efficient Market Theory 69
Paul Samuelson 69
Eugene Fama 71
Evaluation of the Efficient Market Theory 75
2.7 CAPM 77
Capital Asset Pricing Model 77
After the CAPM: APT and the Anomalies 80
2.8 Option Theory 81
Appendix 2A The Mathematical Statistics of Diversification 83
Appendix 2B The Black and Scholes Option Formula 87
Works Cited 88
3 Heterodox Investment Theory 96
3.1 The Criticisms of Modern Investment Theory 96
3.2 Political Finance 97
3.3 Fractal Finance 100
3.4 Bubble Finance 104
3.5 Behavioural Finance 106
3.6 Evolutionary Finance 108
Dynamic systems 109
Complexity 110
Emergence 111
Formal and Experimental Evolutionary Finance 111
3.7 Evaluation of the Criticisms 112
Work Cited 113
4 Investment Theory, Probability Theory, and Uncertainty 116
4.1 The Logos of Probability 116
4.2 Probability Beliefs in the Portfolio Theory 117
4.3 Markowitz’s Defence of Personal Probabilities 122
4.4 Investment Theory after Markowitz’s Portfolio Theory 125
4.5 Evaluation of the Probability Theory within Investment Theory 126
4.6 Risk against Uncertainty 129
Knight 130
Keynes 132
Von Mises 133
4.7 Arguments for Uncertainty in Economics 134
Knight 134
Keynes 136
Von Mises 137
McCloskey 138
Taleb 139
4.8 Coping with Uncertainty 139
Knight 140
Keynes 143
Von Mises 144
McCloskey 146
Taleb 147
4.9 Implications of Uncertainty for Investment Theory 147
4.10 A Thought Experiment with Predictability in Investment Theory 151
An Example of Arbitrage 154
The Thought Experiment 155
Option Theory 159
4.11 Closing Remarks about the Thought Experiment 161
Appendix 4A A Formal Proof of the Thought Experiment 162
Works Cited 165
5 The Rhetoric of Investment Theory 169
5.1 Rhetoric 169
The Current Rhetoric 169
Plato on Rhetoric 171
Aristotle’s Art of Rhetoric 172
Rhetoric in the Twentieth Century 174
5.2 The Rhetoric of Economics 175
Rhetoric and Philosophy of Economics 178
Anti-philosophy and the Moral of Rhetoric 180
5.3 Metaphors and Stories 182
The Rhetorical Tetrad 182
Metaphors and Stories in Investment Theory 184
5.4 Virtues 188
Works Cited 189
6 The Culture of Investing 192
6.1 Culture, Economics, and Finance 192
The Relevance of Culture 192
Klamer’s View of the Culture of Economics 194
Notions of Culture: Klamer and Hofstede Compared 196
Culture and Uncertainty: Hofstede’s View 197
Culture and Uncertainty: Schön’s View 198
6.2 Values, Decision Making, and Phronesis 199
6.3 Methodology of the Investigation of the Culture of Investing 202
Culture of Dutch Professional Investors 202
Ethnography Includes Personal Observations 203
Interviews 204
Literature on the Culture of Investing 206
Pitfalls of an Investigation into Culture 207
6.4 Personal Observations 208
6.5 Literature on the Culture of Investing 214
6.6 Innovative Case 1 The Management of Investment Risk 218
Introduction Theo Kocken 218
Risk Management 219
An Economic Explanation of the Failing of Portfolio Theory 221
A Behavioural Explanation of the Failing of Portfolio Theory 222
How to Invest 224
The Use of Options 224
What Should Be Done About the Current State of Finance? 226
6.7 Innovative Case 2 Shell’s Scenarios-approach 227
Introduction Peter Heijmans 227
Scenarios Instead of Statistics 228
Investing in General 229
Scenario Thinking Applied to Investing 230
How to Make Scenarios 231
6.8 Innovative Case 3 Investment Beliefs 232
Introduction Alfred Slager 232
What Are Investment Beliefs? 233
Beliefs About Capital Markets 234
Beliefs About the Organization of Investments 235
What Should Be Done About the Current State of Finance? 236
6.9 Values, Conversations, Their Justification, and Innovation 237
The Values of Investors 237
Wealth 237
Optimism 238
Rationalism 239
The Conversations of Investors 239
The Market and the Economy 240
Talk by the Model 240
Money Must Be Put to Work 240
Doubt and Reassurance 241
The Justification of the Culture of Investing 241
Evaluation of Innovative Practices 242
Works Cited 244
7 Conclusions 249
Index 259