MacKenzie D. An engine, not a camera.. How financial ... - TiERA

4Tests, Anomalies, and MonstersAlmost from the beginning, empirical difficulties shadowed the finance-theoryideas discussed in chapter 2. These difficulties were perhaps at their greatestwith the Modigliani-Miller propositions. Merton Miller put it this way: “TheM&M [Modigliani and Miller] model was much harder to implement empirically[than the Capital Asset Pricing Model]. ...It’s very difficult to prove‘empirically’ the M&M propositions holding even as approximations. You ...can’t hold everything else constant.” (Miller interview) In other words, youcan’t empirically identify in an unequivocal way the “risk classes” described inappendix A.Fundamental theoretical contributions as they were, the Modigliani-Millerpropositions remained controversial as claims about the world. For example,the topic of “dividend policy and capital structure” occupies more than 140pages in one of the main modern textbooks on corporate finance (Brealey andMyers 2000, pp. 437–579). The Modigliani-Miller propositions provide thosepages with their central organizing themes, but the text’s authors treat theempirical validity of those propositions as still an open question. Indeed, myimpression is that a significant strand of opinion in financial economics doesnot regard the propositions as empirical claims, viewing them more as “benchmarks”against which deviations can be analyzed. 1Initially, matters seemed entirely different with respect to the Capital AssetPricing Model and the efficient-market hypothesis. There was, Fama laterrecalled, “a brief euphoric period in the 1970s when market efficiency and the[capital asset pricing] model seemed to be a sufficient description of the behaviorof security returns” (Fama 1991, p. 1590). However, there too difficultiessoon began to accumulate.Of the early attempts empirically to test the Capital Asset Pricing Model,the most supportive major study was by Fama and his Chicago colleague JamesD. MacBeth (1973), who used the data tapes of monthly stock returns from1926 to 1968 constructed by the Center for Research in Security Prices