Informative Prices, Rational Investors: The Emergence of the Random Walk Hypothesis and the Nineteenth-Century "Science of Financial Investments"

In a series of articles marking the recent anniversary of Louis Bachelier's "Théorie de la spéculation," historians have reevaluated Bachelier's role as a forerunner of modern financial theory and reconsidered the historical origins of the latter. They have emphasized anew the importance of Bachelier in the development of modern financial theory (see Sullivan and Weithers 1994, 31; 1991, 165; Harrison 1997, 175; Courtault et al. 2000) and, in the process, have reconsidered the timing of two achievements normally credited to him: the options pricing theory and the random walk hypothesis. Historians now believe that that theory and hypothesis were developed in the 1860s and 1870s, well before the publication of Bachelier's "Theory of Speculation" in 1900, and perhaps not by Bachelier at all (Jovanovic 2000, 2001; Jovanovic and Le Gall 2001).

For example, Franck Jovanovic and Philippe Le Gall have recently argued that the key elements of the random walk hypothesis were first formulated in a book by Jules Regnault, called Calcul des chances et philosophie de la Bourse [Chance calculus and the philosophy of the stock exchange], published in 1863 in Paris. More precisely, the argument is that "a French forgotten economist, Jules Regnault, laid the basis of modern stochastic models of price behaviour" (Jovanovic and Le Gall 2001, 333). While Louis Bachelier was more interested in probability theory and took options prices as a mere application of this theory (he was a mathematician by training), Regnault was an economist genuinely interested in developing a probabilistic model of financial markets (Jovanovic 2000, 397). There are no other publications left by Regnault, and not much is known about his life.

Seven years later, another (also now forgotten) economist pushed financial theory a bit further. In 1870, Henri Lefevre de Chateaudun published a book called Traité des valeurs mobilières et des opérations de Bourse: Placement et spéculation [Treatise of financial securities and stock exchange operations].¹ He was the former private secretary of the Baron Rothschild (himself a banker and financial speculator) and was influenced by Pierre-Joseph Proudhon, of all social and economic thinkers.² Besides the Traité, Lefevre wrote several books on trade, merchant apprentices' manuals, and another treatise on financial speculation, as well as one on horse race gambling. He invented an instrument for simplifying calculations when betting on horse races (the "auto-compteur"; see Lefevre 1871) and another one for financial investors (the "abacus of the speculator"). In the late 1860s, Lefevre started a nationwide investment company called Union Financière and published an investment journal, the Journal des placements financiers. In his Traité, he developed the graphic method known as the "payoff diagram" (discussed in section 6) and used later by Bachelier.

Seen in this perspective, Louis Bachelier continued and developed insights already formulated by economists thirty to forty years earlier. The "prehistory of efficient capital markets" (LeRoy 1989, 1586) began then in the 1860s, not in the 1900s. This contradicts the view according to which before Bachelier there were no (theoretical) efforts in the field of options pricing, or, more generally, of academic financial theory (Harrison 1997, 175). If we accept the arguments advanced by Jovanovic and Le Gall, we cannot say anymore that Bachelier was "ahead of his time" (Bernstein 1992, 18). Louis Bachelier appears instead as one member in a series of economists intensely preoccupied with developing financial economics. This, however, does not diminish his merits: Bachelier was a creative developer of ideas and preoccupations that other economists had already formulated.

At this point, a question arises. Neither Jules Regnault nor Henri Lefevre did actually write for an academic readership. They saw themselves as financial speculators. Their publications explicitly addressed investors, and their aim was to provide practical advice. As mentioned above, Henri Lefevre invented several practical devices...