When theory met markets, the results were gold.

That forecast turned out to be spectacularly on-target: At the end of 1998, the Dow was at 9,181, just thirty-seven points off the forecast. It hit 10,000 in March 1999, six months early. Back in 1974, of course, no one knew the predictions would be right. But there was enough interest in the data and the forecasts from brokers and institutional investors that Ibbotson—by this time a junior professor at Chicago—set up a side business of updating the stock and bond data every year.

The Ibbotson Associates yearbooks became part of the library of every serious money manager. Ibbotson also began publishing wall posters that showed how stocks beat bonds through the decades; they became fixtures in the offices of brokers and financial advisers. And the forecasts of double-digit annual stock market returns became, especially after they started coming true in the 1980s, accepted as an eternal investing verity-playing a major role in getting pension funds to shift from bond-dominated to stock-dominated portfolios. Ibbotson Associates became, along with Barr Rosenberg's Barra, a pillar of a new investing establishment, built not in the traditional big-money redoubts of New York and Boston, but in Chicago and even more so along the West Coast—where UCLA, UC-Berkeley, Stanford, Rand, and even NASA's Jet Propulsion Laboratory provided the talent. Other advisory operations founded or reinvented in those days along quantitative lines included Wilshire Associates and Russell Investments, both of which created new, broader stock market indices that became important benchmarks for money managers. Morningstar, founded by a Chicago MBA who wanted to bring similar tools to individual investors, came along a little later, in 1984. Bill Sharpe, while he didn't actually start a company of his own until the 1990s, was an influential consultant to pension funds and money managers.

It wasn't just the consultants and research shops. San Francisco's Wells Fargo Investment Advisors built upon its pioneering indexing work to become what was in 2008, under the name Barclays Global Investors, the biggest money manager on the planet. Number two, State Street Global, was a big indexer and asset allocator as well. Every other money manager of any size in the world now uses at least some of the quantitative tools introduced in the 1970s by finance professors.

What's more, one 1970s quant tool made it far beyond the money management industry. Armed with Ibbotson's measure of the equity risk premium and Barra's (or some other firm's) measure of a stock's riskiness in relation to the overall market, one could now calculate any publicly traded company's cost of capital. This metric was the holy grail, the search for which had launched Merton Miller and Franco Modigliani on their 1950s assault on old-style finance. Now it was within anybody's reach. Calculating the cost of capital in this manner soon became standard practice for MBA students, investment bankers, consultants, and corporate finance executives. This was the first great wave of quantitative finance.

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.