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The Birth of Modern Finance

As MIT Sloan celebrates the 100th anniversary of the founding of Course XV, we have taken the opportunity to produce a commemorative book that captures the significant and lasting contributions of our faculty, students, alumni, and staff to the fields of management and management education.

Here, we share an excerpt from the book chapter entitled, “Economics, Finance, and Accounting.” We hope that you will want to read more. If so, please visit: http://mitsloan.mit.edu/100years/book.php to order your copy.

Franco ModiglianiFranco Modigliani

Many scholars and industry leaders agree—the birthplace of modern finance is MIT. The Institute lays claim to pioneers like Fischer Black, Stewart Myers, and John Cox, as well as Nobel Laureates Paul Samuelson, Robert Merton, Myron Scholes, and Franco Modigliani. Formed in the 1960s, long before many business schools recognized finance as a distinct field of study, the MIT Sloan Finance Group is responsible for research breakthroughs that helped shape finance theory and practice over the last 40 years—and continue to do so today.

The modern intellectual history of finance begins with Paul A. Samuelson, who started his lifelong career at MIT in 1940. The Department of Economics named him assistant professor when he was 25 years of age and a full professor at 32. In the 1960s, Samuelson became interested in finance and wrote several seminal papers on topics including asset allocation and the fallacy of time diversification, and, of course, on the pricing of warrants and options, which would become the start of something much bigger. In 1970, he was the first American to win the Nobel Prize in Economics. John Kenneth Galbraith wrote in 1977 that, “Generations of students have learned their economics from Paul Samuelson, the pre-eminent teacher of his time.” Economic historian Randall E. Parker calls him the “Father of Modern Economics,” and the New York Times considered him to be the “foremost academic economist of the 20th century.”

Samuelson’s legacy is certainly far-reaching. He attracted many talented collaborators and mentees to MIT, including Robert Solow, Paul Krugman, Franco Modigliani, and Joseph Stiglitz, all of whom went on to win Nobel Prizes. Following Samuelson’s lead, the two departments—Economics (in the School of Humanities, Arts, and Social Sciences) and Finance (in the School of Industrial Management)—forged a lasting bond that made each stronger. In 1952, when the School of Industrial Management moved into the newly acquired Sloan building at the east end of campus, the Department of Economics left the Hayden Library, where social sciences was located, and joined their management colleagues, a sign of their close relationship.

What Dean Penn Brooks wrote in his last Annual Report in 1959 is still true today:

The area of economics has particular significance for the field of management, and the strength of the School has always been magnified by our faculty’s close working arrangement with MIT’s distinguished Department of Economics and Social Science. The collaboration is not only in the design of the teaching programs, where members of that Department contribute substantially to our program, but also in the close personal research relationships that exist between members of the two groups.

Robert MertonRobert Merton

One of Samuelson’s most significant contributions to the field of finance, however, was mentoring a rather unlikely PhD candidate in 1967—an applied mathematics student from Caltech who had no prior economics training and who was rejected from every other economics program to which he applied. That young maverick was Robert Merton. Yale, Harvard, Berkeley, and Stanford didn’t want him—the MIT Economics Department welcomed him with open arms. Then-Dean William Pounds advised Merton to skip the traditional finance courses (because he’d get bored quickly and leave) and enroll in Paul Samuelson’s mathematical economics course. Merton showed up the first day of registration, walked into Samuelson’s open door, and didn’t leave for three years. “The rest was history,” says Merton. “I lived in his office from the end of that class on campus.”

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