The Economics Book

262

IT IS POSSIBLE

TO INVEST

WITHOUT RISK

FINANCIAL ENGINEERING

D

uring the 1960s the

institutional foundations

of the post-war world were

steadily eroded. The Bretton Woods

system (pp.186–87) of fixed exchange

rates, pegged against a US dollar

that was in turn locked into a fixed

price against gold, was starting to

buckle. The US was running

persistent trade deficits (where

imports outstrip exports), while

recurrent balance-of-payments

crises elsewhere provoked calls for

the introduction of freely floating

exchange rates. In 1971, President

Richard Nixon took definitive

action: he unilaterally canceled the

dollar to gold relationship, ending

the whole Bretton Woods system.

IN CONTEXT

FOCUS

Banking and finance

KEY THINKERS

Fischer Black (1938–95)

Myron Scholes (1941– )

BEFORE

1900 French mathematician

Louis Bachelier demonstrates

that stock prices follow a

consistent but random process.

1952 US economist Harry

Markowitz proposes a method

to build optimal portfolios

based on diversifying risk.

1960s Capital Asset Pricing

Model (CAPM) is developed to

determine the correct rate of

return for a financial asset.

AFTER

1990s Value-at-Risk (VaR) is

developed to measure the risk

of loss on a portfolio.

Late 2000s Global financial

markets collapse.