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February 02, 2012


 Luis Enrique

yep, as I understand it Jensen and Murphy recommended lots of things that didn't happen (bosses having to hold shares for long durations, getting paid zero if performance is poor) and all that didn't get "performed" in reality, just the pay bosses lots bit did.


Ingenious financial models for pricing mortgage CDO tranches persuaded major banks to take on the risk of correlated mortgage defaults in the US market. And that hasn't proved to have high social benefits.

Insurance depends on diversification of risk. Option-writing depends on hedging of risk. Neither applies to the Rutland housing market. A seller of the insurance you want would just be another AIG waiting to be bailed out. The best way for this risk to be carried is by individual house-owners. They have a hedge of a sort in that they are short the house they're going to move into when they move out of this one and sell it.

Tom P

Thing is some of the concepts have become unchallengeable in my corner of the world. Try arguing with a corp gov person at an asset manager - agency theory is all they have, so they struggle to see much wrong (apart from the odd Fred Goodwin) wrong with pay in PLCs.

George Hallam

"In this sense, the problem is not with economics, but with a class structure that causes the “real world” to be a corrupted and perverted form of a market economy."

This sounds like a cop-out.

Why not say that the problem is that economics as a discipline is structured to serve the class interests of the rich.

Alex Marsh

Mackenzie's work (which is excellent btw) also indicates that you have to take account of the private interests of the economists. Economists were paid handsomely to advocate, on the basis that the economy would be more efficient if such markets existed, for changes in the law so that settling futures contracts in cash not goods was legal (previously it had been defined as gambling). Similarly, economists didn't only develop the theory around CAPM but also set up companies to provide information to the market based upon the model.

I don't disagree with your position, but you could also argue that these are ongoing processes and some of the products/markets you mention just haven't arrived yet. Shiller of course is associated with the Case-Shiller house price index, and for the last five years at least there have been attempts to develop derivatives in house prices that hang off the C-S and other such indices. Case has been an advocate of developing retail products off the back of such new financial instruments which will allow individual homeowners to hedge. It may happen eventually.


So you are saying that the problem with this state sponsored enterprise (economics is mostly state funded) is that it is too influenced by power? Isn't this the libertarian argument against state funding?

Ted Rogers 321

In fairness to Donald he does also describe moments of 'counterperformativity': situations where the application of financial models produce real world results which are the opposite of the model's propositions. The back half of his and Milo's Black Scholes paper discuss this at length (the enduring volatility skew, post crash). His work on the 0.3 default correlation assumption in the structuring of CDOs also suggests a kind of counter-performativity at work.

digital options

Very interesting post. the Gerald Debreu and Kenneth Arrow theory is very unique and interesting. And I also liked what you said about the problem being not with economics, but with the class structure.

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