Saturday, October 20, 2012

Akerloff on Efficient Markets Hypothesis



I particularly like his comments (@13 min or so) on Snake Oil and financial assets. When market participants are exuberant (overly confident) it is natural for firms to create and market new assets that are overpriced relative to actual value, or have dangerous risk-return tradeoffs. For the latest example, in natural gas drilling rights during the recent boom (now a bust), see here.

See also Venn diagram for economics.

The cover illustration of Akerloff and Shiller's book. Are there any economists outside of Chicago who still don't believe in "animal spirits"?


7 comments:

Kevin Kind Songs said...

Much of what he states is contradicted by the latest brain research. In fact, what seems to be happening is that pretty much everything we think we knew is being debunked by brain research -- economics especially.

Marketing, business and econ are still in the "flat earth" stage of knowledge about behavior. The earth is not flat and some know it but you can get along OK pretending it is.

It is however, increasingly hard to give lectures and have conferences on the flat earth -- or advise clients it is. But you know, most of the earth's population believe it is flat so real knowledge is only for the specialists. Very, very few people fly in a plane and see the earth's curve.

Hauser Quaid said...

Could you please give an example of his statement that is contradicted with brain research? He was talking about a group behavior which could be very different from behaivior from individual closed in one room doing tasks while he/she get's her brain scaned.

efalken said...

A lot of this is semantics. I consider markets 'efficient' in the sense that it is very difficult to make above-average returns, not that it is impossible, and certainly not in the sense that with hindsight we won't see a lot of mistakes. Note very few called the market crash before it happened, but now it seems so obvious, which is the 'hindsight' bias common to those who aren't in the arena day to day.


As per his assertion about regulations, it makes sense at 30k feet, but upon inspection lacking. Finance has a lot of regulation, the OCC, FDIC, SEC, state insurance boards, FSA, OTS, the Fed, and now the CFPB. He notes we need 'better' regulations, but remember that prior to 2007 regulators were not merely encouraging low-doc, low-downpayment mortgages, but actively prosecuting companies that didn't meet targets to lend to 'historically disadvantaged minorities'. The only way to do that was by lowering the criteria (aka getting rid of discriminator 'traditional credit history' hurdles), which is why no regulator brought forth this complaint prior to 2007. Fannie Mae's underwriting platform, DeskTop Underwriter, served as a template for what is legal and moral, encouraged by the government, and this encouraged the housing bubble.


So, regulation was pushing the wrong way in 2007, and he shows no reason why or how it can be made better merely by asserting it should be (as if anyone is against 'better', a straw-man argument; his opponents like me merely say regulations are, in practice, counterproductive, as they were so clearly in 2007, which is why the focus should be on lowering them).

Yerba Mate said...

Regarding your question about believing in animal spirits, and commenter Kevin's mention of a "flat earth" stage -- quit making a straw man out of economics. Frontier economics isn't what you learn in undergrad, or what you read about in the news, or even what Nobel winners speak about to the public, which is often about decades-old research. Frontier economics is loaded with models that go far beyond the old school models most people have in mind-- for example, how agents update their beliefs in a non-Bayesian way given new information, or maximize non-expected utility, or get utility from beliefs themselves.

Additionally, it's not whether economists do or don't believe that humans are perfectly rational, strategic agents; most of them are perfectly aware of all the decision-making biases we exhibit on a daily basis, both through their knowledge of the experimental research (endowment effect, loss aversion, violations of transitivity, etc.), and the obvious real-life evidence staring them in the face. Economists do the best they can at relaxing as many assumptions as possible while maintaining analytical tractability. And when a model does a "good enough" job at explaining real world behavior, there is no need to go further. For example, it doesn't matter whether people actually do constraind optimization problems in their heads when they are at the grocery store, but if they behave *as if* they do, then they can be modeled this way. There are lots of trade-offs involved as well; in order to relax assumption in one dimension of a problem, it makes sense to simplify the others.

But I suppose that getting rigorous with these things will also be criticized as "physics envy." Oh well, I guess economists must suck one way or another in order for you to feel good.

steve hsu said...

What fraction of academic economists are "frontier" economists? You might be surprised to know that I talk to a lot of economists and most are not the frontiersmen you refer to. But maybe the ones I know are too old ...

Is the Shiller quote below (2008) now completely out of date?

http://infoproc.blogspot.com/2008/11/heterodoxy-strikes-back.html

"I BASED my predictions largely on the recently developed field of behavioral economics, which posits that psychology matters for economic events. Behavioral economists are still regarded as a fringe group by many mainstream economists. Support from fellow behavioral economists was important in my daring to talk about speculative bubbles.

Speculative bubbles are caused by contagious excitement about investment prospects. I find that in casual conversation, many of my mainstream economist friends tell me that they are aware of such excitement, too. But very few will talk about it professionally.

Why do professional economists always seem to find that concerns with bubbles are overblown or unsubstantiated? I have wondered about this for years, and still do not quite have an answer. It must have something to do with the tool kit given to economists (as opposed to psychologists) and perhaps even with the self-selection of those attracted to the technical, mathematical field of economics. Economists aren’t generally trained in psychology, and so want to divert the subject of discussion to things they understand well. They pride themselves on being rational. The notion that people are making huge errors in judgment is not appealing."

Yerba Mate said...

I don't know. By definition, all (good) economic researchers should be at the frontier, in that they are doing novel work in some way, but not all are. In microeconomic theory, particularly decision theory, there has been a lot of progress lately in the sort of "fringe" areas, but it will take time for these developments to filter into the macro models that matter for predicting business cycles and unemployment.

By the way, I agree that there is a taboo against highly nonstandard models, but this is for good reason; a lot of times, rather than explaining behavior with some new behavioral hack, it can be explained with the same old rational beings after just enriching the model. And this is valued highly, as it should be; it's better to have a unified theory rather than a bunch of ad-hoc modifications that pick up all these quirks. On a related note, I loved it when it was pointed out that what was previously described as "cognitive dissonance" when monkeys overwhelmingly chose certain M&Ms after choosing them before was really just a necessary consequence of Bayes rule. http://tierneylab.blogs.nytimes.com/2010/01/27/monkeys-candy-and-cognitive-dissonance/

MtMoru said...

Economists suck every kind of dick. From big black African elephant dicks to tiny Chinese rice dicks.

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