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Post-Autistic Economics Network |
with
permission from the THE JOURNAL OF INVESTING SPRING 2003
Notes
in the Margin—The 2002 Nobel
Prize in Economics GEORGE M. FRANKFURTER Not to lag behind the hard sciences,
the Nobel Committee for Economics, in October 2002,announced the names of this
year’s laureates, Vernon Smith and Daniel Kahneman.
First, I wish to express my warmest congratulations to the recipients, and
assure them that the prize is well deserved. In fact, at the 1998 Aspen
conference of the Institute of Psychology and Financial Markets, an
organization that numbers Smith and David Dreman
among its founders, I told Vern that when the Nobel Committee eventually
recognized the contribution of experimental economics to the field he would
be a recipient of the prize. He dismissed my remark as something typical of
an economist’s forecast—always, unfortunately, wrong. By 1985, Mr. Akerlof
had met the two psychologists whose research and experiments, in
collaboration with various economists, produced many early findings of behavioral economics. One of them, Amos Tversky, died in 1996; the other, Daniel Kahneman, now at Princeton, taught a graduate seminar on
psychology and economics with Mr. Akerlof at
Berkeley. If the signal in 2000 were lost on anyone, this year it could
have been stronger only if it had been awarded posthumously to Sigmund Freud
or Carl Gustav Jung. De facto, the committee said, to paraphrase our former president, “it’s
the behavior, stupid.” It also said that neoclassical economics, financial or
otherwise, is not the wave of the future, because we cannot explain the
complexities of 21st century life without understanding human behavior as individuals and as a group, considering
culture, politics, and ethnicity. The decision is also a certification that
the movement that got its start in France in the summer of 2000, spreading
all over the world, and calling itself post-autistic economics (a synonym for
post-modernity in economics), or PEA for short, is not just legitimate, but
also the way to go. Should we be happy, and break out the beer and the potato chips?
Not so fast! Financial economics, or modern finance, is still ruled by the
high priests of neoclassical orthodoxy. Also, in the theological seminaries
of the religion of market efficiency (RME) (read
departments of finance all over the land), the young cadres of theologians
are taught that no world exists not described by the CAPM,
the OPM, APT, or the free cash flow hypothesis. It
is strictly Friedmanian [1953] positivism, reinterpreted
by Sharpe [1964] and Fama [1965, 1970, and 1998]. According to the RME, models that do
not imitate physics have no place in finance. Those who man the bastions of
the faith do not like to hear how Uchitelle sees
the future Behavioral economists help to explain
how booms persist while busts, like the one that the United States may now be
entering, are difficult to reverse. Their research sheds light on why
identity—the traits people assign to themselves and to others—plays a huge
and often damaging role in the economy. If the behaviorists
are correct, shares of companies on the New York Stock Exchange are
overvalued and the Dow Jones industrial average has further to fall. And if
the behaviorists prevail, the mainstream view of a
rational, self-regulating economy may well be amended and policies adopted to
control irrational, sometimes destructive behavior.
Twenty-five years of deregulation might lose its appeal [2001, Section 3, p.
1]. Positivists especially dislike that last sentence. What they do
like is models of mathematics, and the fanciest statistical footwork
econometrics can invent. Thus, they are
ARCHing, GARCHing,
and EGARCHing all the data they can lay their hands
on, and that is how they train the young cadres in the field. Anything else
is not only discouraged but also strictly verboten. A letter I received from a former student after my retirement
includes this paragraph (not quoted in its entirety): Earlier this year in my Theory of Finance course someone
questioned why utility theory, because it is based on assumptions which we
know to be false, is worthy of study. Professor Tunnelvision
[I changed the name to protect the guilty] implied that because of Friedman’s
admonition that assumptions are not important, and that all that matters is
how a theory measures up to empirical evidence, we don’t have to bother with
such “philosophical” questions. I responded that Friedman’s assertion was in
itself the statement of a philosophical position. Another student commented
that “this is a finance course and not a philosophy course.” My response was
that if we consider ourselves “scientists” we could not shrink from such
philosophical questions. Dr. Tunnelvision responded
that Friedman’s position was THE philosophy of modern finance, and that if I
hoped to get published it would be my philosophy as well. Everyone in the
class laughed at this statement but me. I left the class wondering what
self-respecting scientist would make a statement such as that. There are several key philosophical issues wrapped in this
paragraph, leaving one wondering about the delicate undersides of educating
our new cadre of researchers. It would be impossible to squeeze them all into
the confines of this comment, but one issue is very bothersome to me, and
should concern everyone else who believes that the major role of science, and
the ultimate responsibility of scientists, is discovery. This is the distressing fact that Professor Tunnelvision
gave the student the practical advice that if the young Ph.D.s, fresh out of
school, want to keep their jobs, and eventually be promoted and tenured, they
must fall in line. This makes progress next to impossible, and one must find
the way to break out of this vicious cycle. As I have argued elsewhere, behavioral
finance must grow from cooperation with other social scientists. This is a
difficult road to travel, because such cooperation is practically
non-existent. Candidates for the Ph.D. in finance, if not totally prohibited,
then are actively discouraged from acquiring an education in these sciences,
and they are surely foreclosed from writing a dissertation in combination
with these scholars. So, if we want to shed the straight jacket of modern finance,
and many—the Nobel Committee for sure—think we should, we must do something
about it beyond talk. This is so because talk is not merely cheap; it is
unfortunately as inefficient as our markets are. The Nobel Prize is both
money and (perhaps foremost) prestige, but the chances of one of us in
economics, financial or otherwise, getting it, are less than any one of us in
economics, financial or otherwise, being drafted by the NBA. We need “campaign finance reform” in academia that would provide
generous funding for work done in cooperation with other disciplines of the
social sciences—because, sadly, what talks is money, not just in politics,
but in academe as well. This would provide the right incentive for faculty
and Ph.D.s to do research that would not be forthcoming otherwise. We also need outlets for work that today has no chance at all to
be published in the leading journals of the field. This is desperately needed
because of the structure of the promotion and tenure process. If one is not
published in the leading journals of the field, one does not get promoted or
tenured. If one does research that is not in line with the religion of market
efficiency, one does not have a chance to publish in these journals,
regardless of the quality of one’s work. This Catch-22 must be broken if we want
to make progress. Fortunately, there are a few journals that would consider favorably good-quality work that is not “traditional”: The Journal of Psychology and Financial Markets, IRFA, JEBO, Homo Oeconomicus, and a few others
on the purely academic side, and this Journal on the side that also tries to
communicate with the practitioners of finance. I have personally benefited
from the willingness of these journals to publish my work that has been
iconoclastic. If more people, perhaps far better than I, would send their
work to these journals, perhaps they would be considered after a while the
leaders of the field.* This is not a quick and easy road, but unfortunately there is no
other one to travel. And perhaps we will find the intellectual resources among
our fellow academics that would go beyond the mental capacity needed for yet
another event study. Ergo, as both an optimist and a survivor, I rejoice in the
decision of the Nobel Prize Committee, as I hope for a scientific revolution
to come and to still to be around to witness it. ENDNOTE * Ironically, modern finance/financial
economics has replaced what in the early 1960s was called traditional or
institutional finance. As modern finance succeeded in colonizing financial academia,
it is now called traditional finance. This is to show how words serve as
place holders, as their real meaning changes. In the semiotic theory of de Saussure [1959], the former is la parole, and the latter is la langue. REFERENCES Akerlof, George. “The
Market for ‘Lemons’: Quality Uncertainty and the Market Mechanism.” The Quarterly Journal of Economics, 84 (1970), pp. 488-500. Fama, Eugene F. “The Behavior of Stock Market Prices.” Journal
of Business, 38 (1965), pp. 34-105. ——. “Efficient Capital Markets: A Review of Theory and Empirical
Work.” Journal of Finance, 25 (1970), pp. 383-417. ——. “Market Efficiency, Long-Term Returns, and Behavioral Finance.” Journal
of Financial Economics, 49 (1998), pp. 283-306. Friedman, Milton M. “The Methodology of Positive Economics.” In
M. M. Friedman, ed., Essays in Positive
Economics. Chicago: University of Chicago
Press, 1953. de Saussure, Ferdinand. Courses in General Linguistics. New York:
McGraw-Hill, 1959. Sharpe, William F. “Capital Market Prices: A Theory of Market
Equilibrium under Conditions of Risk.” Journal of
Finance, 14 (1964), pp. 425-442. Spence, Michael. “Job Market Signaling.”
The Quarterly Journal of Economics, 87 (1973), pp. 355-374. Tversky, Amos, and Daniel Kahneman. “Judgment Under Uncertainty: Heuristics and
Biases.” Science, 185 (1974), pp. 1124-1131. ——. “Prospect Theory: An Analysis of Decisions under Risk.” Econometrica, 47 (1979), pp. 263-291. Uchitelle, Louis. “Following
the Money, but Also the Mind.” New York
Times. February 11, 2001, section 3, page 1.
To order reprints of this article, please contact Ajani
Malik at
amalik@iijournals.com or
212-224-3205. THE JOURNAL OF INVESTING GEORGE M. FRANKFURTER is Lloyd F. Collette professor
Emeritus at Louisiana State University. He is network professor at the
Graduate School of Management, Sabanci University, Tuzla/Istanbul, Turkey. pitypalaty@cox.net |