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Home > Financial Information Sources > Financial Modeling > An Engine, Not a Camera: How Financial Models Shape Markets

Financial Information Sources

An Engine, Not a Camera: How Financial Models Shape Markets

Donald MacKenzie
Inside Technology Series
Cambridge, Massachusetts: MIT Press, 2008
377pp, ISBN: 978-0-262-63367-3
www.mitpress.mit.edu

This new book argues that the emergence of modern economic theories had a profound impact on how the modern financial system evolved. It discusses how new structures in financial markets and the growth of derivative products was dependent on these economic theories explaining how they worked and giving them legitimacy. It also explores finance theory in terms of recent financial crises.

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An Engine, Not a Camera: How Financial Models Shape Markets (Inside Technology)

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In An Engine, Not a Camera, Donald MacKenzie argues that the emergence of modern economic theories of finance affected financial markets in fundamental ways. These new, Nobel Prize-winning theories, based on elegant mathematical models of markets, were not simply external analyses but intrinsic parts of economic processes. Paraphrasing Milton Friedman, MacKenzie says that economic models are an engine of inquiry rather than a camera to reproduce empirical facts. More than that, the emergence of an authoritative theory of financial markets altered those markets fundamentally. For example, in 1970, there was almost no trading in financial derivatives such as "futures." By June of 2004, derivatives contracts totaling $273 trillion were outstanding worldwide. MacKenzie suggests that this growth could never have happened without the development of theories that gave derivatives legitimacy and explained their complexities. MacKenzie examines the role played by finance theory in the two most serious crises to hit the world's financial markets in recent years: the stock market crash of 1987 and the market turmoil that engulfed the hedge fund Long-Term Capital Management in 1998. He also looks at finance theory that is somewhat beyond the mainstream -- chaos theorist Benoit Mandelbrot's model of "wild" randomness. MacKenzie's pioneering work in the social studies of finance will interest anyone who wants to understand how America's financial markets have grown into their current form.

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