How academic debate transformed into Wall Street wealth.

If you cut it in half, basically the variance in the first half and the variance in the second half were the same. That's not by chance. That means that our particular society settles in with a certain amount of surprise being acceptable and indeed interesting. Too much is too much, too little is too little, so that's quite mysterious.

Rosenberg, Black and William Sharpe of Stanford outlined an approach to financial risk that has survived and mostly thrived to this day. They had varying views about market efficiency—Rosenberg didn't much believe in it; Sharpe and Black did. What all three shared was a conviction that, however correct or incorrect stock prices might be, the most straightforward and thus most teachable path to investing success lay in better understanding risk.

In this view, risk couldn't necessarily be captured or quantified perfectly, but that didn't mean it wasn't worth trying to quantify. Rosenberg opened a consulting business upon his ideas. His firm, Barra, provided measures of beta-a stock's sensitivity to the movements of the overall market—that were enhanced with fundamental data on earnings, sales, industry sector, and the like.

"Barr's better betas" (also known as "bionic betas") were more palatable to active money managers than the bare-bones versions offered previously. Rosenberg himself was a uniquely effective proselytizer for portfolio theory among Wall Street's unconvinced. His belief that stock picking was far from pointless, coupled with a quiet confidence and charisma not found in a lot of finance geeks, propelled him to near cult-leader status in investing circles. "As Rosenberg speaks, a hush typically falls over the audience," claimed a 1978 cover story in Institutional Investor. "In the manner of sinners, heads are slightly bowed. Eyes are moist and a bit glassy. One can almost hear the murmurs of ‘Amen, Brother' and ‘Praise the Lord.' "

END OF PART ONE

From the book The Myth of the Rational Market: A History of Risk, Reward, and Delusion on Wall Street by Justin Fox. Copyright © 2009 by Justin Fox. To be published by Harper Business, an imprint of HarperCollins Publishers.

Photograph Ryan McVay/Getty Images Creative