Current Crisis - Behavioural Finance saw this coming.

econ09

Is this true? Could this all have been predicted using Behavioural Finance.

The environment changed and risky behaviours ensued. Kahnemnas and Traverskys "Prospect Theory" should have seen that risky deals were happening that caused this.

This could have been prevemted???

Time Magazine

Short answer: not really.

silverharp

very predictable under Austrian economic theory:p

Time Magazine

Not even.

It defines how you define predictable. Behavioural Finance, particularly the work by Minsky (who had the rather nice doctoral supervision team of Schumpeter and Leontief) rather than that of Kahneman and Tversky does suggest that when times get good people get stupid and a business cycle ensues. That is what happened, but it's not like behavioural finance isolated the sub-prime mortgage market as dodgy and nobody listened. BF does suggest though that markets should be more regulated to control for Minsky-like behaviour, so perhaps had BF-inspired policies been enacted then the sub-prime market would not have emerged.

The Austrians are on the other side of the story. Their mantra, asymptotically, is "If you interfere with markets, something will go wrong." This is true, there were interest rate cuts and so on and something went wrong. But again, it's not like it had any incredible specific predictive power.

The analogue of all this is that no model can predict everything. No matter how many bells and whistles you apply to your DSGE model, it will not be able to tell whether Michael Dell decides to stay in Ireland or move to Poland. And even when the model is exceptionally powerful, let's say it looks at competitiveness indices and thinks we're going to start losing large employers, it won't be able to tell whether Michael Dell decides to leave in August 2007 or March 2009. Similarly it is almost impossible to predict whether the sub-prime market will crash or not. If clear evidence existed that it was a really bad idea, then it's unlikely anyone would invest. Be it prospect theory-based or Austrian, no model can predict stuff like that.

silverharp

The Economist wrote: »

The Austrians are on the other side of the story. Their mantra, asymptotically, is "If you interfere with markets, something will go wrong." This is true, there were interest rate cuts and so on and something went wrong. But again, it's not like it had any incredible specific predictive power.

You are right that no economic theory could predict several year in advance that a particular market would be the first shoe to drop , but Austrian theory seemed to alert its adherants to be wary as the credit expansion post 2002 was phony. All that could be said was that the excess credit that was being produced would flow into housing, commodities and other markets. That the public imagination got fixated on housing was by the by.
What I found amusing over the past few years was the likes of Greenspan saying he couldnt spot a bubble while at the same time the "Austrians" were saying there was one and the Fed was behind it. I've no idea if the Fed was confused by its own metrics eg core rate v looking at growth in money supply, maybe they just became pawns of short term political policy.

econ09

Bankers became less risk averse during the global economic boom and took on extra risk as a result. they became overconfident. forecasts were made that were too extreme and as a result bad decisons were made.

Behavioural finance suggests that this should have been noticed?

10000maniacs

econ09 wrote: »

Is this true? Could this all have been predicted using Behavioural Finance.

The environment changed and risky behaviours ensued. Kahnemnas and Traverskys "Prospect Theory" should have seen that risky deals were happening that caused this.

This could have been prevemted???

The theory of behavioural science was invented by humans. There lies the problem. The majority of the human species have narcissistic tendencies whether they agree with that or not. It clouds our ability to think rationally. The first step to rehabilitation is for everyone on this island to accept responsibility for their culpability in this disaster.
We are all to blame for the economic mess. Those who bought apartments at hugely exorbitant prices. Those who lent us the money to do so. Those who bought 4x4 jeeps to keep up with the neighbour next door. Those who paid €8.00 for a latte and roll in O'Briens. Those who jumped ship from honourable companies to get a €5000 boost in their salary.
Only when we as a nation can take responsibility for this hole we now find ourselves in, then we can start to recover. Think on the Public sector.;)

eamonnm79

10000maniacs wrote: »

The theory of behavioural science was invented by humans. There lies the problem. The majority of the human species have narcissistic tendencies whether they agree with that or not. It clouds our ability to think rationally. The first step to rehabilitation is for everyone on this island to accept responsibility for their culpability in this disaster.
We are all to blame for the economic mess. Those who bought apartments at hugely exorbitant prices. Those who lent us the money to do so. Those who bought 4x4 jeeps to keep up with the neighbour next door. Those who paid €8.00 for a latte and roll in O'Briens. Those who jumped ship from honourable companies to get a €5000 boost in their salary.
Only when we as a nation can take responsibility for this hole we now find ourselves in, then we can start to recover. Think on the Public sector.;)

I agree with you about 90%
Accept it is usually always people who should have known better that initiate the ability for us citizens to unleish our narcissism. Banks allowing people to build up huge personal levels of debt, huge mortgages being given to people who cannot afford them under any type of stress test. Politicians repealing legistlation like glass steigal or giving property tax breaks in the middle of a housing boom.
Re Austrian theory above, the most relivent austrian thoery at the moment is the one that states that economic downturns can not be avoided but only delayed and made worse because of these delays.