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Forerunners of Modern Financial Economics

A Random Walk in the History of Economic Thought, 1900–1950

Donald R. Stabile

The economists who began using statistics to analyze financial markets in the 1950s have been credited with revolutionizing the scholarship of investing and with inaugurating modern financial economics. By examining the work of economists who used statistics to analyze financial markets before 1950, Donald Stabile provides evidence about the forerunners of modern financial economics.
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Chapter 5: Risk and Diversification in the Boom of the 1920s

Donald R. Stabile


The myth that the 1920s were a decade of irrational behavior in the stock market is an enduring one. After all, even Thorstein Veblen used some inside information on an oil company and made a small speculative gain from an investment in stocks early in the decade, something we would not have expected from him. At one level, the myth has justification. Stock prices did rise dramatically. The Dow started the 1920s at 100, a level it had first reached in 1906. In the recession of 1920–21, it fell to the mid-70s. It recovered to 100 by 1925 and then started to rise, reaching 150 in 1926 and 200 in 1927. By then a bull market became evident, with the Dow hitting 300 in early 1929 and continuing to a high of 381.7 in early September. The annual growth rate in stock prices for the period was 18 percent (Bierman 1998, p. 3). To be sure, there were some down periods, such as a decline of almost 50 points in late 1928, but the overall trend was upward. Then the crash came. Stocks hit their high on September 3, 1929. For the next two months, what is now remembered as the great crash took place. Starting in late October, in six days the Dow lost 30 percent. It rebounded slightly in December to finish at 248.48 at the end of 1929. This was a sharp decline, to be sure, but the Dow was still at its level of late...

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