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NUMBERS GAME

CAPITAL IDEAS: THE IMPROBABLE ORIGINS

OF MODERN WALL STREET

By Peter L. Bernstein

Free Press -- 340pp -- $24.95

In the late 1960s and '70s, hard-nosed traders and seasoned analysts scorned the ideas of eggheads who studied the financial markets. Get real, they said. The market is efficient? Stock prices can't be predicted? Nonsense!

The scoffers were too hasty--and it cost them and their clients billions. The theoretical insights of academics became the basis of stock-index equity funds, futures markets, options on futures, modern portfolio theory, and other critical props in today's global financial markets. A generation of investors is benefiting from the academics' most crucial ideas: the importance of portfolio diversification, the link between risk and reward, and the inherent difficulty of trying to best other skilled players in a competitive market.

Peter L. Bernstein's Capital Ideas is an enjoyable tour through this continuing revolution. An economic consultant and longtime market participant, Bernstein tells his tale largely through sketches touching on the backgrounds, personalities, and insights of financial innovators. At times, the story meanders, and the language falters, but Bernstein's approach does convey many aspects of change in the financial markets for the nonacademic, nonmathematical reader.

His exploration begins in 1900, with the work of Louis Bachelier. A French mathematician ignored in his time, Bachelier, as a doctoral student, wrote an extraordinarily dissection of why prices in the capital markets are impossible to predict. Another obscure player was astrophysicist M. F. M. Osborne, who in 1959 wrote about the random character of stock prices--in Operations Research, a Navy Dept. journal. It took the diligent work of economists and finance specialists such as Harry Markowitz, William Sharpe, James Tobin, and Paul Samuelson to expand on such insights and eventually transform the markets.

Many economists, for instance, championed the idea of investing by buying the market--an index fund--rather than relying on an individual's stock-picking ability. The trust department at Wells Fargo Bank was among the first to latch onto the idea--and became a global money-management juggernaut. And money manager Barr Rosenberg did yeoman work tying academic theories to real-world investment.

Much good has come from this revolution, Bernstein asserts, and he's right: Because we understand better how the markets work, we can manage money and hedge risk better. Bernstein also argues cogently that many attacks on innovation are suspect: anti-intellectual, impractical, and rooted in nostalgia. Still, readers concerned that razzle-dazzle trading techniques could lead to a market crash as severe as 1987's may question Bernstein's optimistic view. After all, until Bloody Monday, portfolio insurance was an acclaimed innovation--and it now shares blame for the crash. But that debate only makes this tale more fascinating.CHRISTOPHER FARRELL


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