Incorporating Human Behavior Into Wall Street Mathematical Models 300
After watching the stock market struggle for the past year, financial experts from Wall Street and academia are putting more effort into bringing behavioral modeling into their complex financial calculations. "The risk models proved myopic, they say, because they were too simple-minded. They focused mainly on figures like the expected returns and the default risk of financial instruments. What they didn't sufficiently take into account was human behavior, specifically the potential for widespread panic." Analysts are looking at research from other fields to supplement the hard mathematics of risk assessment. "Financial markets, like online communities, are social networks. Researchers are looking at whether the mechanisms and models being developed to explore collective behavior on the Web can be applied to financial markets." Another avenue they're exploring is how we react to the spread of disease. Jon M. Kleinberg, a computer scientist at Cornell, said, "The hope is to take this understanding of contagion and use it as a perspective on how rapid changes of behavior can spread through complex networks at work in financial markets."
Austrian Economics, anyone? (Score:5, Informative)
Incidentally, Austrian economics also posits that interference with the operations of markets produces a boom-bust business cycle, by promoting misallocation of scarce resources. It's worth noting that many Austrian economists were predicting our current economic crisis well before it occurred, when the more mainstream Keynesians were still calling it a golden age of economic development.
What is being proposed here is to continue to view markets as purely mathematically modelable phenomena. Economic decisions occur on the most local of levels, the individual level. No model accounts for the variability of the individual. For a Keynesian-style planned economy to function requires omniscience.
Re:Such as? (Score:3, Informative)
nonsense. what happened was people acted in their own rational [so they thought] interest... few people want to intentionally harm themselves... the system was such that people acting to defend themselves from economic decline caused an avalanche of others doing the same. If someone believes that it is in their best interests to sell their stock it would be irrational of them to just sit there and watch their wealth erode away... but it would also mean that if they did sell their stock under incomplete information conditions the entire system becomes comparatively irrational...
Not a level/transparent/open playing field (Score:3, Informative)
if conditions exist that favor making money through "immoral behavior" then that is what will happen.
Some point to (substantial) evidence that the playing field itself could be called as you say, "immoral": http://www.chrismartenson.com/crashcourse/chapter-15-bubbles [chrismartenson.com] (ch16 and 17 as well) and some related news: http://www.google.com/search?q=audit+the+fed [google.com]
Re:Incorporating Human Behavior Into Wall Street M (Score:3, Informative)
often times it was closer to being fraudulent than risky... the current system allows companies to leverage far more capital than they have in assets [fractional reserve banking] that is very dependant on the stability of the money supply... consequently when there are monetary expansions followed by monetary restrictions by the federal reserve we observe a collapse of the system catalysed by panic.
Krugman recently called for similar adjustments. (Score:5, Informative)
"How Did Economists Get It So Wrong? "
http://www.nytimes.com/2009/09/06/magazine/06Economic-t.html?_r=1&em=&pagewanted=all [nytimes.com]
Re:Austrian Economics, anyone? (Score:3, Informative)
Crime families and drug gangs are economic phenomena.
Both usually comprise an underground economy of immigrants (people outside the normal purview of government) working to avoid government regulation of business activity.
Comment removed (Score:5, Informative)
Re:Austrian Economics, anyone? (Score:3, Informative)
Boom bust cycles are inevitable with fractional banking and the such. You may be able to print an infinite amount of money by adding zeros to the notes. But that doesn't increase the supply of stuff to buy with that money. Opportunity cost is --IMO the true cost. Because money is not the ends. Its a means to an ends. This is the sort of thinking that is usually refereed to as Austrian school of economic. (but a concrete definition is a little more tricky IMO)
Biggest risk is regulation (Score:2, Informative)
Apparently some of these guys pay as little as 20% which is how they can offer the returns they do. The problem is that when a regulator hears that you're ripping off a sick grandma who has trouble even understanding the forms they tend to pass laws. Some of these may invalidate existing agreements or put the companies creating them out of business. When the companies aren't there you run into all sorts of management issues - like the premiums not being paid, paperwork not being filed and payments not forwarded. I think Virginia has laws dictating at least 60% of the face value be paid (not sure on the % - search for viatical settlement for better info).
The other main risk is when the company simply can't find enough suckers as one company now being prosecuted for fraud in Texas found out. They found and took investors money but never bought the life settlements and burned through much of the cash. It could be they never intended to buy them, but I suspect if they could have found them they would have bought them as its a small amount to pay to keep the state off of your back - certainly less than they've lost from being put out of business.
Re:Austrian Economics, anyone? (Score:5, Informative)
The basic idea of Austrian economics is that the study of economics is an a priori discipline.
Which is to say, it's an attempt to reason from assumptions instead of draw conclusions from evidence. An a priori discipline is an arcane way of saying a philosophy, mathematical system, or religion. It's the opposite of science, which is a posterioi.
Re:Such as? (Score:2, Informative)
You're not aware that the tulip guild and Dutch parliament redefined tulip futures contracts to be options contracts, that the price increases corresponded with a lull in a major war, that the market collapsed when Dutch authorities stepped in and halted sales of the contracts, and that the Dutch government was promulgating an expansionary monetary policy at the time?
You don't consider lack of contractual enforcement, warfare, and monetary inflation to constitute "government intervention"?
http://en.wikipedia.org/wiki/Tulip_mania#Legal_changes [wikipedia.org]
Re:Death Insurance gambling (Score:5, Informative)
Oh, not at all. The insurance companies HATE this idea, they do NOT want people to be allowed to invest in life insurance policies, because these investors will do anomalous things like PAY THE POLICY PREMIUMS, and not let the policies lapse. As it is now a huge number of life insurance holders let their coverage lapse (either through financial problems, laziness, cost gets too high, etc.) In that case the insurance company gets the benefit of all those payments already made (sometimes DECADES of them), without any of the cost (i.e. having to pay out the policy when the holder dies).
Re:Austrian Economics, anyone? (Score:2, Informative)
I guess I'm not sure how this is supposed to prove that praxeology is absurd. Suppose you like vanilla ice cream, but I give you a punishment every time you taste vanilla ice cream, and I give you a reward every time you taste chocolate ice cream. Maybe after that, you'll start preferring chocolate ice cream. So what? Your preferences have changed slightly, that is all. Your conscious actions are still intended to improve your satisfaction. The only thing that has changed is what satisfies you.
Of course, maybe you don't like my example (that's why I asked for a concrete one from you).
Now, I know that some people say Austrian reasoning is basically a tautology. And I understand that, because I don't see how you can disprove praxeology. But you can't find a triangle that disproves Pythagorean's theorem, either; does that mean Pythagorean's theorem is useless?
Harry Seldon (Score:1, Informative)
would be proud. Psychohistory lives!