Eugene Coyle wrote: > There is nothing in neo-classical micro on production that is anything > but dishonest and obfuscating. Bright students that want to make > fortunes take Principle and then quickly switch to Finance rather than > economics because they see that the economics has nothing to do with > the world. Those students (and our leaders of industry and commerce) > don't bother with a mastery of micro. They study Finance but are > delighted to have economists throw dust in the eyes of the public/voters.
Curiously though, modern finance theory is not the result of some generalization of the actual practice of finance. Rather, it may well be the purest, most genuine product of economic thinking. For reasons obvious to economists (i.e. incentives), not even one percent of the insights of modern finance are owed to professional finance practitioners. Most of them, by far, are due to economists. Fourty years ago, finance was still a compendium of detailed institutional material, with very little analytical structure to pin it with. In and by itself, probability theory and statistics were insufficient to reshape finance. The work by the French mathematician Louis Bachelier in the late 19th century (on the random dynamics of asset prices) was ignored. So it took the work of a bunch of economists to revolutionize finance. By the mid 20th century, some economic insights had began to jell as a prototype analytical framework. Partly due to Keynes, but also to conventional economists like Irving Fisher and John Hicks. Then enter Paul Samuelson's papers, and most importantly the formal incorporation of uncertainty into economic models by Von Neumann and Morgestern, the Arrow-Debreu state preference approach to pricing contingent goods under general equilibrium (the Arrow-Debreu prices are to modern finance what the straight line is to classical geometry), and everything went downhill afterwards. Let me be more specific: *All* the fundamental building blocks of modern finance are owed to the economists: (1) efficient market theory (Cowles, Samuelson, Mandelbrot, Fama), (2) portfolio theory (Harry Markowitz), (3) capital asset pricing theory (Arrow, Debreu, Treynor, Sharpe, Lintner, Merton), (4) option pricing theory (Black/Scholes), (5) the theory of informational imperfections (Stiglitz, Akerlof), (6) agency theory (Jensen, Fama, Stiglitz, Meckling), (7) behavioral theory (Kahneman, Tversky, Shiller). The fist four constitute the framework, the "benchmark." *All* of them the result of economists using the most conventional economic approach. The last three add layers of concretion to the abstract benchmark. Also the product of the economists. The quick-and-dirty, practical (or "policy") areas in finance all rely on the benchmark: (1) valuation (arbitrage pricing, an economic concept); (2) portfolio choice (mean-variance analysis); (3) capital budgeting (the NPV criterion, which follows from the former); (4) capital structure policy (the irrelevance proposition by Modigliani/Miller, an instance of Coase's theorem: under certain conditions, the assignment of property rights is irrelevant in resource allocation), (5) optimal financing policy (due to tax, bankruptcy, agency, and behavioral implications), and (6) dividend policy (Modigliani/Miller again with no tax, agency, etc. effects). So, the idea that behavioral finance (the application of behavioral economics that has grown most explosively lately for reasons obvious to economists) refutes traditional asset price theory or traditional portfolio allocation or traditional anything is as silly as saying that Marxist relative prices directly tied to labor values are refuted by production prices. No such thing. In the way finance people look at it, the traditional models of modern finance theory provide naive benchmarks. Then more "realism" is added. So far, the "anomalies" or gaps between the limit concept and observed reality are better explained as coming from three sources: agency issues, informational asymmetries, and the quirks raised by behavioral finance. But things won't stop there... Hegel would not have expected any different. _______________________________________________ pen-l mailing list [email protected] https://lists.csuchico.edu/mailman/listinfo/pen-l
