I’ve sat in two doctoral level investment classes for my degree. It’s not one of my fields because I just don’t want to take the derivatives seminar. I actually have a lot of disdain for the field now that I’ve done the proofs on the major models. My ex husband worked 20 years for an insurance company in their investment department doing the real thing. It was one of the reasons I actually left him. I find the entire field pretty insufferable. Unfortunately, it’s also one of the highest paying fields you can have as an academic. It’s much easier to get big publications in Finance than Economics. That’s basically because there really isn’t an awful lot of theory in finance. It’s mostly data mining looking for some kind of theory. As you can probably tell by now, I’m not really popular with the Investment professors. They don’t understand me primarily because I’m not out to make money. (Well, that and I refuse to call Eugene Fama God) My research is always based on contrariness about the current asset pricing models we teach. I especially disdain the ones that we teach to MBAs and Finance majors.
A lot of Finance is based on two assumptions that I can’t buy. One is that the market follows a random walk. (This is Fama’s big contribution for which he expects to get a Nobel, but hasn’t managed to date.) A lot of time is spent looking at the equity markets saying you can’t beat the market or really forecast it because it’s a completely random series. The second is that the investor is a rational being. Most of the field total ignores the old Keynesian idea of ‘animal spirits’. That’s the idea that the market can get a herd mentality and spook at various events and move like a bunch of scared cows.
There’s a field in Finance that’s beginning to get a little bit of respect but still is considered a little out there. That’s probably, why it’s the only parts of Finance and Investment theory that intrigues me. It’s called Behavioral Finance. It looks for anomalies in the market and tries to find the reasons for them based more on human psychology rather than trying to just call them odd events. That’s why I was happy to read this account, Irrational everything, written by Guy Rolnik on Prof. Daniel Kahneman. Kahneman’s a collector of stories of irrational behavior when it comes to people and finance decisions. His voice would really add some flavor to the current collapse of modern finance. Here’s a non finance example that just tickles me every time I read it.
But the story Kahneman recalls when asked about the economic models at the root of the current financial crisis is actually taken from history, not an experiment. It concerns a group of Swiss soldiers who set out on a long navigation exercise in the Alps. The weather was severe and they got lost. After several days, with their desperation mounting, one of the men suddenly realized he had a map of the region.
They followed the map and managed to reach a town. When they returned to base and their commanding officer asked how they had made their way back, they replied, “We suddenly found a map.” The officer looked at the map and said, “You found a map, all right, but it’s not of the Alps, it’s of the Pyrenees.”
According to Kahneman, the moral of the story is that some of our economic models, perhaps those of the investment world, are worthless. But individual investors need security – maps of the Pyrenees – even if they are, in effect, worthless.