The Financial Crisis and the Systemic Failure of Academic Economics

Abstract

Abstract:The economics profession appears to have been unaware of the long build-up to the current worldwide financial crisis and to have significantly underestimated its dimensions once it started to unfold. In our view, this lack of understanding is due to a misallocation of research efforts in economics. We trace the deeper roots of this failure to the profession's insistence on constructing models that, by design, disregard the key elements driving outcomes in real-world markets. The economics profession has failed in communicating the limitations, weaknesses, and even dangers of its preferred models to the public. This state of affairs makes clear the need for a major reorientation of focus in the research economists undertake, as well as for the establishment of an ethical code that would ask economists to understand and communicate the limitations and potential misuses of their models.

Mean field limit of a behavioral financial market model

“…Each agent is described by the three properties (γ i , c i , m i ). The excess demand is simply the average of the investment propensities (1) and the time evolution of the herding pressure is given by (2). At each time step t k := k ∆t, k ∈ N, the agent switches his market position with the probability λ P (t k , c i , m i , S).…”

“…In the past years, there has been a number of financial crises (Black Monday 1987, Dot-com Bubble 2000, Global Financial Crisis 2007). Unfortunately, these crises all have in common that classical financial market models fail to explain their origin and existence [2,11]. Additionally, these models fail to explain the existence of stylized facts, which are assumed to be one important aspect to the creation of market crashes [20].…”

Whither economic complexity? A new heterodox economic paradigm or just another variation within the mainstream?

“…Primarily, one may argue that complexity economics stands a good chance of having a considerable effect: 1) Cries for a 'new economic thinking' are today louder than ever -last, but not least, the recent global financial crisis can be understood as the empirical anomaly which pushed neoclassical economics into a state of crisis, and complexity economics can be seen as a potential alternative (see e.g. Colander et al 2009;Kirman 2010); 2) complexity economics is a 'sister science' to complexity theories in other disciplines including the natural sciences (and some Nobel laureats) -this lends considerable 'natural authority' to this approach; 3) during the advancement of a scientific discipline, the degree of complexity (in common parlance) becomes higher -complexity science seems to be the next step in this direction in the domain of economics (but not only economics); 4) complexity economics is a highly formalized approach satisfying demands for accuracy and professionality. Moreover, since the bigger and more influential camp -MCE -does not claim to oppose neoclassical economics…”

Book Review

“…More interesting than Hubbard's analysis of the financial crisis, much of which is similar to others' critiques, (1)(2)(3) is the author's discussion of Nassim Nicholas Taleb. Taleb wrote The Black Swan and has received much attention for his criticism of financial markets.…”