Monday, 11 August 2008

Soros and Equilibrium: Holiday Reading 1

While I was away, perhaps slightly masochistically*, I read the new Soros book, The New Paradigm for Financial Markets: The Credit Crisis of 2008 and What it Means. It is not a particularly good summary of what happened, nor a detailed analysis of why it happened, but it does make an interesting point. Soros claims, I think very plausibly, that finance is reflexive, that is that the very study of it changes the object being studied. I have written about this before, but it is interesting to see Soros making much of the role of reflexity in the formation of asset price bubbles.

Of course, this feature of finance renders the received wisdom of classical economics rather suspect. In particular, models in finance are not time-stable in the same way that a good piece of science is, simply because the way market practitioners behave changes. The S&P return distribution with over half of all trades done by machine (2008) is unlikely to be the as that when most of the market went via floor traders (1988).

* 'We read popular finance books so you don't have to dot com' has not, funnily enough, been registered as a domain name...

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