'Strangers and Brothers’: The Secret History of Profit, Value and Risk. An inaugural lecture.

Introduction [First Paragraphs] As political history is signposted by decisive battles and the rise and fall of great leaders, so the history of finance is marked by speculative booms and busts. From the failure of the futures market in Dutch tulips in the seventeenth century, to the South Sea Bubble of 1720, and more recently the Wall Street crash and, more recently still, the various ‘Black Mondays’, ‘Black Wednesdays’ and so on. These bubbles are characterised by upward speculation that leads prices to depart from some notion of underlying value, followed by a sharp readjustment, marking the re-imposition of the rule of value. The pattern is well illustrated by the ‘dot-com’ boom of 2000. In spite of the misleading signals about value given by financial markets, we are witnessing an increasing dominance of such markets as the sole arbiter of valuation. Not only is this a tautology, but its application has some important and potentially dangerous consequences. Some economists, following the development of the Black-Scholes option pricing model, have gone as far as arguing that volatility itself is a source of value.2 As Bernstein notes, ‘the product in derivative transactions is uncertainty itself’.3 According to this model, inter alia, the greater the risk, the higher the price of the asset. Such attitudes afforded scant protection to the Black Scholes inspired hedge fund,Long Term Capital Management when its losses of $3.75bn shook the world financial system in 1998.