Reflexivity

BESman

I was doing some research on George Soros the other day and discovered that he is a strong believer in reflexivity which is "where the biases of individuals enter into market transactions, potentially changing the perception of fundamentals of the economy" - Wikipedia.

It goes on to describe the application of reflexivity in the current crisis:

"A current example of reflexivity in modern financial markets is that of the debt and equity of housing markets. Lenders began to make more money available to more people in the 1990s to buy houses. More people bought houses with this larger amount of money, thus increasing the prices of these houses. Lenders looked at their balance sheets which not only showed that they had made more loans, but that their equity backing the loans—the value of the houses, had gone up (because more money was chasing the same amount of housing, relatively). Thus they lent out more money because their balance sheets looked good, and prices went up more, and they lent more. This was further amplified by public policy. Many governments see home ownership as a positive outcome and so first home owners grant and other financial subsidies — or influences to buy a home such as the exemption of a primary residence from capital gains taxation — mean that house purchases were seen as a good thing. Prices increased rapidly, and lending standards were relaxed. The salient issue regarding reflexivity is that it explains why markets gyrate over time, and do not just stick to equilibrium—they tend to overshoot or undershoot." - Wikipedia.

I found this to be particularly insightful. I had never heard of reflexivity and it certainly was not introduced to me in university. Has anyone ever encountered it before, in university or elsewhere? And is it a credible theory with empirical research and big names attached?

Anonymous1987

It's Soros' own philosophy from observing the market rather than an economic theory as far as I know.

SkepticOne

Maybe it exists under a different name in economics. I don't see how you can understand the likes of the Irish property bubble, for example, without some version of the concept outlined by the OP. Once a bubble goes on long enough it is not seen as such even by conservative entities. I remember reading articles about the amount lent out by Irish banks during the boom that argued that it was not a cause for alarm because the loans were backed by property.

But seeing bubbles for what they are or recognising the extent of them seems to be an unsolved problem in economics. During the situation in Ireland, various factors such as demographics tended to be roped in to support the non-bubble hypothesis.

silverharp

there are any amount of market commentators or market historians that understand the concept although I had not heard of that particular term. The basic idea is that that price drives leverage which becomes circular. Fundamental analysis then feeds in to it to justify the high prices.