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The Myth of the Rational Market: A History of Risk, Reward, and Delusion on Wall Street by Justin Fox

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Chapter 5: Modigliani and Miller Arrive at a Simplifying Assumption

Finance, the business school version of economics, is transformed from a field of empirical research and rules of thumb to one ruled by theory.

Four years after John von Neumann and Oskar Morgenstern published their equation-filled guide to weighing potential rewards and losses in an uncertain future, economist Milton Friedman and statistician Jimmie Savage made a startling proposal. With just a few tweaks, they wrote, the von Neumann-Morgenstern utility theory could describe the way real people made economic decisions. At the very least, they argued, “individuals behave as if they calculated and compared expected utility and as if they knew the odds.”

To head off the obvious ...

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