Financial Remakes
The Myth of the Rational Market is by the author’s own admission modelled on Peter Bernstein’s Capital Ideas: The Improbable Origins of Modern Wall Street. It is a history of a fundamental tenet of finance theory - the efficient market hypotheses (EMH) - which, its critic’s argue, has come up short in the GFC. More strident commentators even blame the EMH for the crisis.
Fox, a well credential-ed financial journalist, has written a clear and accessible history that successfully targets the non-financial reader. Its rendition of history, which owes much to Bernstein, is essentially correct and identifies the ill-fated tendency to elevate the EMH to a status that heavily distorted academic theory and policy approaches to markets.
The Myth of the Rational Market is at its best when telling the story and somewhat weaker in dealing with the nuances of the theory itself. Fox puts a lot of faith in the challenge of newer theories – behavioural finance and the adaptive markets hypotheses – and sees these as the way forward. Time will tell but these theories may be just as flawed. Ultimately, hypotheses are just that and market behaviours and the animal spirits may prove difficult to model.
A significant advantage of Fox’s book is that it brings the story up-to-date (Bernstein’s book was first published in 1992). Fox also is perhaps more sceptical of the theory than Bernstein, who knew and was close to many of the proponents and was much less critical.
The wonderful titled - Lecturing Birds on Flying – is a remake of and a paean to the Black Swan, also known as Nassim Nicholas Taleb. The book is a polemic against the Black-Scholes-Merton option pricing model. Other major themes are frenzied criticism of financial economics, economists, business schools, tenure, academics turned practitioners, etc in no particular order of importance.
Like the apostolic epistles, Lecturing Birds on Flying is an extension of the liturgy that Taleb set out in Fooled by Randomness and the Black Swan. The premise is similar if less successful. The book’s ambitious objective, as set out in Taleb’s foreword, to “make society a better, safer and more risk-conscious place” is unlikely to be achieved.
A puzzling aspect of the book is the writing style employed. The reviewer at the Economist was especially taken by the final sentence: “Deliciously paradoxically, the Nobel could end up diminishing, not fortifying, the qualifications-blindness and self-enslavement to equations-led dictums that, fifth-columnist style, pave the path for our sacrifice at the altar of misplaced concreteness.” One reviewer on www.amazon.co.uk commented on the terms “tumultuous tumultousness”, “unconventional conventionalism” and “dogmatic dogmatism”. The reviewer was concerned about persistent double negatives and sought to establish that a reference to an argument as “non-incoherent” means “coherent”?
As neither a linguist or a literary stylist, I can only assume that the author and editor felt the need to experiment with the extremities of the English language and expression to reinforce the message. In A Clockwork Orange, Anthony Burgess created a special teenage slang of the not-too-distant future called “Nadsat”. The effect here is not dissimilar.
In both books, there is an essential contradiction – the idea that models and theories cause market chaos is inconsistent with the fact that both authors says traders and practitioners often ignore models.
Both books miss an essential point about economists and theories. As John Kenneth Galbraith pointed out the only point of economics is to provide employment for economists. The irony is that it is also provides fruitful employment to authors in explaining the theories (in good times) and debunking them (in bad times).
Generally speaking, academic insights, even if correct, can rarely be applied directly to financial markets. Smart traders and investors have always known this and theory and practice are rarely bed-fellows on Wall Street or in the City. Economists and economic theory should not be taken too seriously. After all Keynes’ only regret in life was that he: “did not drink more Champagne”
© 2009 Satyajit Das
