Probabilistic roots of financial modelling: A historical perspective

Abstract

This chapter explores possible probabilistic roots of Bachelier's and Bronzin's work. Why did they choose their specific probabilistic setting? Are there parallels to the early development of life insurance two centuries earlier, when the emerging statistical probabilism, advanced by major mathematicians of that time, was explicitly used to "domesticate" speculation and to transform it to a morally acceptable business model? Perhaps, the models of Bachelier and Bronzin grew out of the same attempt, namely transforming speculation to an ethical sound investment science. However, things were much more complicated at the turn of the 20th century: the public opinion about speculation and financial markets was very negative, and the probabilistic understanding was in a fundamental transition, from determinism to a genuine notion of uncertainty. This is best illustrated in the probabilistic modelling of thermodynamic processes, most notably in the work of Boltzmann (one of Bronzin's teachers), and the emerging field of social physics. From this perspective, it is not surprising that financial markets were not a natural topic for probabilistic modelling, and the achievement of Bachelier, Bronzin and their possible predecessors is all the more remarkable. © 2009 Springer-Verlag Berlin Heidelberg.