I was at an econ department event tonight, and an interesting question came up in a conversation: is financial theory largely a stagnant field?

the last pure theory contribution of any significant real world usefulness is black scholes theory.

Perhaps it's just waiting for a few funerals to clear out the old-growth giants and let some saplings with heretical ideas grow.Or, perhaps the theory has reached the limit of what very small teams (e.g. a prof + a couple of grad students) can accomplish with a small research budget. What could finance theory do if given a $1,000,000,000 in grant money to do big experiments in the markets?

QuoteFinance theory is the field that deals with investment making decisions and the concept of the time value of money.As long as investment decisions are lookep upon as simple optimization problems (MPT, CAPM) there can't be much progress.

QuoteOriginally posted by: KackToodlesthe last pure theory contribution of any significant real world usefulness is black scholes theory.Kack,I agree. I'd say progress in finance theory parallels the progress of Quantum Mechanics. There hasn't been any in many many years.N

QuoteOriginally posted by: NQuoteOriginally posted by: KackToodlesthe last pure theory contribution of any significant real world usefulness is black scholes theory.Kack,I agree. I'd say progress in finance theory parallels the progress of Quantum Mechanics. There hasn't been any in many many years.NI'd say the best ones are kept secret, a la Simons

QuoteOriginally posted by: TraderJoeI'd say the best ones are kept secret, a la Simons I doubt simmons has made a conceptual breakthough in finance. He makes his money by running faster computers (aka, brute force).

I think, it was end 80ies / begin 90ies? when an economics researcher (Brian Arthur, Stanford) found that the widely prayed rule: "when markets come close to saturation, prices per piece go down" does not hold for all businesses. Microsoft, Gilette,..showed the opposite.I think, this is because economists did concentrate on one-sided markets (like game theory concentrates on ono to one games?).In two-sided markets we usually have the situation that one side needs to be subsidized to get money from the other side (Windows and Office, razors and razor-blades, Acrobat Reader and Writer,...). I call this co-evolution. Co-evolution has complex feed-back structures and leads to complex systems.In fact, Arthur was one of the founding members of the "Santa Fe Instizute for Complex Systems".Do we have such research in qf?

Q: Is finance theory largely a stagnant field? As always, I must disgree with Kack. No. Finance theory has alot more to offer. There are quite a few rough gems out there waiting to be developed which include:(i) Behavioural Finance: This will take off whenever (or if) someone can develop it into a cogent mathematical framework. (1979 and onwards)(ii) A full explanation of Momentum as it partially contradicts some of the more classic finance theories (Carhart 1997)(iii) Household Finance. Alot of finance theory explains corporate financial decisions. John Y Campbell believes that explaining the way mums and dads actually make their household finance decisions has not been fully explored yet. (see AFA 2005 seminar speech)(iv) Real options (developed in the early to mid 1990s)Do I need to keep going ?..........Anyway, some of the items listed above helps you to make money while others are an intellectual challenge more than anything else.

QuoteOriginally posted by: KackToodlesQuoteOriginally posted by: TraderJoeI'd say the best ones are kept secret, a la Simons I doubt simmons has made a conceptual breakthough in finance. He makes his money by running faster computers (aka, brute force). What? Rentec gets their edge from Cuch's design patterns. Good OO beats speed everytime.

I doubt Rentec is using any inventive ideas. I sent them my resume recently. Sorry, not interested.

QuoteOriginally posted by: KackToodlesthe last pure theory contribution of any significant real world usefulness is black scholes theory.... and yet, Bachelier and many others had developed sensible theories for option valuation before Black-Scholes-Merton, leading to similar formulasIn my view (and with some sense of provocation), the reasons why Black-Scholes-Merton eclipsed those very important contributions are:1) The fable of the dynamic arbitrage argument (a very weak form of arbitrage, as every option trader knows)2) The need of financial markets for scientistsRE 1) it is interesting to note that the original Black-Scholes paper was based on a CAPM argument rather than the now familiar arbitrage argument, which is Merton's contribution... And it is arguably the latter which was the definite "selling point" of the theory (recall that it took 3 years or so for Black and Scholes to find a journal for their paper...) It seems that Black, who mostly dedicated his career for the promotion of CAPM within financial and economic theory, was not too happy about this shift of focus. It may well be that the CAPM argument was in fact a "visionary" one which practitioners were not ready to accept.e.

QuoteOriginally posted by: KackToodlesQuoteOriginally posted by: TraderJoeI'd say the best ones are kept secret, a la Simons I doubt simmons has made a conceptual breakthough in finance. He makes his money by running faster computers (aka, brute force). Thowing hardware at the problem is not enough. Maintainable and efficient desktop and HPC applications tend to be the ones that have been well designed. And software is important; it makes numbers come out of the computer.

QuoteOriginally posted by: torontosimpleguyI doubt Rentec is using any inventive ideas. I sent them my resume recently. Sorry, not interested.You must have revealed in your resume that you've been infected with stochastic calculus. They don't hire folks with a poor education.

QuoteOriginally posted by: UnderTheRadar(i) Behavioural Finance: This will take off whenever (or if) someone can develop it into a cogent mathematical framework. (1979 and onwards) I believe in behavioral finance -- but is it surprising? It effectively says "the markets are not perfectly effecient." Except for a few hardcore academic philosophers, who really ever thought that markets are perfectly efficient in the first place? Quote(ii) A full explanation of Momentum as it partially contradicts some of the more classic finance theories (Carhart 1997) It got Cahart a good job and tottled some very weak finance theories. Yawn.Quote (iii) Household Finance. Alot of finance theory explains corporate financial decisions. John Y Campbell believes that explaining the way mums and dads actually make their household finance decisions has not been fully explored yet. (see AFA 2005 seminar speech) See behavioral finance above.Quote(iv) Real options (developed in the early to mid 1990s) Lots of bark -- where's the bite? What is r.o.'s good for in the real world?