14 - A suggestion for simplifying the theory of asset prices

Summary

Introduction

In the opening pages of his essay ‘A Suggestion for Simplifying the Theory of Money,’ John Hicks (1935a) describes his uneasiness as a non-monetary economist trying to deal with a subject, the theory of money at that time, completely deprived of the basic result of the theory of value – i.e. ‘that the relative value of two commodities depends upon their relative marginal utility’: ‘To an ingénu, who comes over to monetary theory,’ he writes ‘it is extremely trying to be deprived of this sheet-anchor. It was marginal utility that really made sense of the theory of value … What is wanted is a “marginal revolution”’ (ibid.: 2).

The same feeling could be perceived by a non-financial economist trying to deal with the theory of asset prices and, more generally, the value of uncertain prospects.

At its very beginnings, in the seventeenth century, the value of an uncertain prospect (i.e. a random variable, in modern language) was defined by its expected value, or just ‘value.’ Christiaan Huygens's (1692 [1657]) book represented, coming as it did just after the years of the Pascal–Fermat correspondence, a milestone in theoretical development: ‘He was trying to justify a method for pricing gambles which happens to be the same as what we call mathematical expectation’ (Hacking, 1975: 95).