Research habits in financial modelling: The case of non-normality of market returns in the 1970s and the 1980s

Abstract

In this chapter, one considers finance at its very foundations, namely, at the place where assumptions are being made about the ways to measure the two key ingredients of finance: Risk and return. It is well known that returns for a large class of assets display a number of stylized facts that cannot be squared with the traditional views of 1960s financial economics (normality and continuity assumptions, i.e. Brownian representation of market dynamics). Despite the empirical counterevidence, normality and continuity assumptions were part and parcel of financial theory and practice, embedded in all financial practices and beliefs. Our aim is to build on this puzzle for extracting some clues revealing the use of one research strategy in academic community, model tinkering defined as a particular research habit. We choose to focus on one specific moment of the scientific controversies in academic finance: The ‘leptokurtic crisis’ opened by Mandelbrot in 1962. The profoundness of the crisis came from the angle of the Mandelbrot’s attack: Not only he emphasized an empirical inadequacy of the Brownian representation, but also he argued for an inadequate grounding of this representation. We give some insights in this crisis and display the model tinkering strategies of the financial academic community in the 1970s and the 1980s.