1. Introduction

Consider the influential financier George Soros, who has run some of the most successful and prominent hedge funds in the 20th and 21st centuries. George studied philosophy at LSE and applied Karl Popper’s theory of general reflexivity to finance, essentially saying that this reflexivity can identify the crucial aspects of asset bubbles from the start of the boom to bust sequence where an “unrecognised trend” is occurring to the climax of the bubble where reality and expectations are fully diverged. Soros suggests this model does not replace fundamental analysis, but that it does supplement it. Soros’ actions have been controversial (consider his $10 billion short against the British pound in 1992). Still, his is a blatant example of the value of the application of philosophy to finance; how an outside perspective such as philosophy to the field of finance can breathe fresh life into it. 

Where is the intersection between Philosophy and Finance? What do they have in common? In the modern academic world, students entering university who pursue these paths seem to totally and distinctly apart from one another. The Philosophy student is steeped in the teachings of Socrates and Aristotle - or so it seems. Meanwhile the Finance student is taught how to predict the stock market using models like the Black-Scholes model and other mechanisms like stochastic calculus (the calculus of random walks). While the Philosophy student is studying whether the pursuit of money is a good end, the Finance student has seemingly determined that pursuing money is de-facto the best end or pursuit for life. But is the distinction between these two fields as simple as this? I don’t think it is.

In the remainder of this essay, I will examine three factors that connect these two fields: metaphysics, logic, and axiomatic truths. I intend not to define finance (although philosophy can certainly assist with this, particularly with regards to its metaphysical nature). Rather, I desire to argue for how philosophy can be useful to the finance. This is an argument that would suggest more students wanting ultimately to end up in the field of finance should study philosophy first, and then study finance later (or to study both of them simultaneously). 

2. Metaphysics of Finance


Where did finance originate? And what does the term refer to? Economic historian Mary Poovey suggests it is a field that developed from mathematical models following the Second World War. Per her, much of early 60th century research dealt with the application of Allied models previously developed for war purposes.

The term ‘finance’ has obtained various senses in the modern world. For one, we think of ‘finance’ in terms of financing or providing capital (i.e. some sort of cash or money). A business might finance their capital project of a warehouse, a greenhouse, or the purchase of heavy mechanical machinery. Second, we might think of finance as the study of models by which one can predict future financial outcomes. This is the case for the study of financial planning. A company such as General Electric or Apple might employ a team of financial analysts to examine their budget on a regular basis. In this way, the company is able to rationalise purchases and expenses. A third notion of the term ‘finance’ is that of mathematical finance. This deals with the axiomatic truths of mathematics and then applies them to the real world. It’s a form of applied mathematics. For example, one might use stochastic calculus to examine the random walk of a stock market. The study of Brownian motion allows one to take a random walk (i.e. a stock which is tracking in the stock market) and then predict a range for its future value. By repeating this process thousands of times, one can arrive at an expected price or value for that stock - this is in essence what Black-Scholes and Monte-Carlo simulations achieve. 

But these are each so different by definition. To what extent, and to which definition do we desire to apply philosophy? There are two analogies to draw closer to a satisfactory answer on this.

3. Philosophy is the study of ordered, structured thinking - logic. 


The first analogy I would make between finance and philosophy is that they are both the study of structured systems. Finance, as mentioned, deals with the production of articulate models that can predict future outcomes from variable factors. What is essential in these models is the inputs. An organisation has within itself the desire to pursue the end of making money. These are often consistent with the desires of the individuals within that organisation, too (who has ever conceived of a president or CEO of a public corporation desiring a long-term goal of acquiring debt and growing in expenses [certainly, non-profits and the like have different end-goals]). Philosophy - and specifically the sub-fields of logic and rationality -  are particularly well-suited for this type of thought. And I am not simply referring to the instrumental good of a person who, say, studies philosophy for three years in order to become a better rhetorician (although this is certainly not a bad attribute and it would indeed make this person a strong salesman - many such individuals are well suited for the investment banking profession which at the Manager-Director level is a glamorous and highly-paid sales position). No, I am referencing this study of structures, of systems of thought. Logic teaches simple axioms of truths. For example, the following logic is true given the premises P and Q where P = It is raining and Q = the ground is wet. It follows that [If P then Q] i.e. If it is raining, then the ground is wet. In essence, logic teaches one how to order a model of thought.

For an example of this in finance, say a private equity firm is evaluating whether to invest $100M in a company for a 80% stake. On what basis should they decide how they ought to invest that money? What should the inputs of their model be? Should they perform their cost-effectiveness analysis (i.e. a discounted cash-flow) on factors such as a) the growth rate of the company’s revenue, b) the debt structure, c) the governance structure, d) other factors? or e) a combination of these factors? Logic can assist in this analysis. Through rational deduction, one can determine which inputs are most closely linked to prudential (evidence based) factors. Hence, revenue might be used as an input in the discounted cash-flow, but only if 1) that company is in an industry where revenue is a primary indicator of growth and 2) growth-rate is the end statistic desired to be exported from the model. In this way, we see the same P and Q —> If P then Q (Modus Pollens) logic mechanism in play. These models are in essence a way of organising our cognition - our thoughts. And if these thoughts are not logically sound, then neither will our financial models.

A counterpoint to the usefulness of logic in finance might be that the financial markets are by nature irrational. Thus, any hyper-rationalised pursuits might seem only marginally useful. Perhaps the study of psychology would be more effective in understanding the behaviour of irrational agents (i.e. the stockbrokers who make trades based on emotion and ‘sense’ the motion of the market). This may be true. However, the study of axiomatic truths like logical do allow for a greater understanding of what the logical inputs of a financial model ought to be. This is valuable.

4. Philosophy and Finance are both the pursuit of axiomatic truths


The second analogy I would make - and this is perhaps along the same lines as the first point - is that both philosophy and finance are attempting to pursue axiomatic truths. Finance has its groundings in mathematical principles. The founders of modern finance - such as Fischer Black who in the 1970s used the mathematical principle of Brownian motion to accurately predict the appropriate price point for equity stock options- were interested in math as an applied science to the real world. Stochastic calculus can be used to predict random walks, as noted earlier. Mathematical principles have allowed for finance to become the field it is today.

Philosophy and mathematics share this struggle of dealing with irrational agents via their models of rationality. Consider Arrow’s theorem which suggests although the individual preferences of voters cannot be added up together, it can be the case that one can reasonably predict an outcome by examining the group of voters as a whole (this is then applied to social choice theory to predict results in political elections). Alternatively, consider Game Theory and the Nash Equilibrium, which searches for results within a matrix which most optimally represent the preferences of those given choices between two (or more) options. There is no answer which adequately solves the problem of irrationality in either Social Choice Theory or Game Theory. Still, these theories have applications. Collective Action towards Global Warming can be justified using famous Tragedy of the Commons idea which suggests if everyone acts as a free-rider then everybody loses (in this case, it results in an Earth where everybody dies).

Pursuing perfect rationality may be idealistic and indeed impossible. Humans are not perfectly rational “econs” who make decisions by correctly calculating the pros and cons, and weighing these measurements against each other. Still, there are elements where rationality is the best option or input that is available. And both finance and philosophy pursue these ends. Quantitative finance has faced criticism for many years, but the field of study was particularly targeted following the 2008 financial crisis. At this time, CDOs (collateralised debt obligations) and similar derivative products were prevalent. It seems wrong that the trading of complex derivatives such as these CDOs (often understood by very few) might result not in a prosperous society but rather in one where individuals in the US and beyond had their houses repossessed. The result of this was a global economic shock not seen since the early 20th century when the Great Depression followed the stock market crash of 1929.

However, consider a counterargument to this. Rather than the bad actor itself, Finance may simply be the tool that has been used to promote capitalism over the past 80 years or so. Sure, the inputs have been wrong in scenarios. However, the criticism ought to be pointed towards the organisation of companies who allow the trading of derivatives without appropriate training. Finance within itself is merely a mathematical mechanism for organising inputs with the expectation of outputs.

In this way, it is not so different from philosophy which has similarly been used for good and ill. I.e. consider Marxist philosophy which has been tyrannically used by individuals like Stalin to rationalise the seizing of property by the Soviet State and to send soldiers into war in the name of their country. Quantitative finance has had its good moments as well as its bad. (i.e. consider effective altruism, whereby wealthy financiers have been able to fund things like Vanderbilt University and Carnegie Mellon.

5. Conclusion


In conclusion, I want to emphasise that I enjoy both finance and philosophy. And I don’t think I ought to be ashamed to admit this. I enjoy thinking about the intricacies of both of these studies. And I feel entirely fortunate to be in a school- an institute - where I can study both of these subjects in detail. Both of these subjects ultimately derive their source of value from the same source - axiomatic truths. It is a delight in both subjects to identify and examine these truths.