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A Crisis of Beliefs: Investor Psychology and Financial Fragility
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Audible Audiobook
Listening Length: 7 hours and 40 minutes
Program Type: Audiobook
Version: Unabridged
Publisher: Tantor Audio
Audible.com Release Date: February 26, 2019
Language: English, English
ASIN: B07P8VWX48
Amazon Best Sellers Rank:
Gennaiolo and Shleifer (GS) are justly eminent financial and macroeconomic economists who have worked long and hard (with several colleagues) to provide a cogent analysis of the financial crisis of 2008. Their main finding is that the dominant "rational expectations" theory is not at all supported from the data, and the common superficial explanations of the crisis ("too big to fail," "criminal banker subterfuge") are wrong. Their alternative explanation is solidily in the behavioralist economics camp (to which I admit proudly to belong). The suggest that investor beliefs are systematical biased by what psychologists Daniel Kahneman (Nobel prize winner in economics) and Amos Tversky (wh died too young to receive the price) call the "representative heuristic." This failure of rational behavior leads investors to underestimate the risk of severe downside failure and excessively to extrapolate current trends into the future.The evidence certainly does suggest that some sort of "bandwagon effect" is responsible for the housing bubble and subsequent financial meltdown, but there is a serious objection to any explanation in terms of investor irrationality: rational investors should simply do better, eventually crowding out the incompetent. Of course, there is a whole literature on this going back to Keynes himself suggesting that rational investors have to be awfully well-heeled to counteract a stampede of crazies. And there are plenty of well-heeled rational investors.An alternative to both rational expectations and irrational investors that makes great sense and that I have worked on for a number of years is "adaptive expectations." GS use this term to mean "mechanical extrapolation", but in the evolutionary game theory literature the term means "try to mimic the strategy of the most successful agents in the economy." Adaptive expectation in this sense are rational provided we recognize that market economies are complex dynamic systems, so it is impossible to solve a plausible model of market dynamics, and hence one cannot optimize with respect to such a model. Adaptive expectations are the best we can do, and they obviously produce outcomes similar to GS's irrational beliefs model; (a) rare events are underrepresented usually because agents who plan for them lose; (b) the success bandwagon effect occurs because in a boom, the most successful agents are doing what the bubble expectations tell them to do.
It’s a very interesting book with a couple of new concepts I liked learning. A layered look at many risks and their combined effects. However, for me, an armchair economist, I thought the first part was very basic and the last half, filled with functions and formulas, too complicated and over my head.I would not recommend it to the average economics reader. What I got out of the book personally could have been presented to me in a ten page article. But I’m not a practicing economist.
Most of us are aware that investor psychology and investor expectations have a role in investment returns.This book shows how investor expectations can be measured objectively, and how investor psychology also has broader macroeconomic implications, including giving rise to credit issuance cycles, credit spread cycles, and returns on debt cycles. It also outlines an elegant model of "diagnostic expectations" (vs "rational expectations" or "adaptive expectations") to formalise this investor psychology.The book shows how selective memory/recall can be explained by representativeness (which is modelled as a likelihood ratio), and how representativeness affects "diagnostic expectations".The book concludes with some "open questions", acknowledging that the model doesn't explain asymmetries in booms vs busts, momentum (i.e., under-reaction to fundamental news), and bubbles (when investors look to market price as a signal for fundamental news).I felt that I got a lot out of the book, but it's a book that has to be read with "pen and paper". While I couldn't follow every mathematical derivation, the overall logic seemed to make sense to me.
Although there are many excellent books discussing the Financial Crisis, this book is unique. It is not just a narrative of what happened, as are the others. It is really a textbook that provides a compelling mathematical framework supporting the narrative. The authors do a good job in establishing/proving the math behind the narrative. They readily explain what the math led to as causes of the financial crisis, but also acknowledge the limitations of their work to date and open issues in applying their approach to broader macroeconomic analysis/forecasting. A major derivative consequence of their work is that it has essentially dealt an apparently fatal blow to the 50-year or so premise of Rational Expectations in economic modelling. A second feature of their work is that it brought some notions of Behavioral Economics formally and directly into their analysis and framework, and these two observations are what lead me to characterize the book as a textbook. I believe it has laid the basis for substantial continued work building on their approach by both themselves and others, work which will attack the open issues they identify, as well as entirely new ones. IMHO, this book is a major contribution to economics and as Steve Allen wrote "This Could Be The Start Of Something" Big.
The two authors explicate the several questions as reaction to the crisis of 2008. It born a new mathematics, founded on the maximization of certain functionals. But the context is that of martingales, that is probability and Brownian motes. So it becomes important what that Gintis tells here. Gintis doesn't be a fool, he is the greatest authority in game theory. He sees and considers many similarities between the evolutive games and the random theory. It exists many situations, where a mix between games and random theory works, so that looks like better than Black-Scholes model.
First rate analysis of the Great Financial Crisis. Provides a persuasive and fact-based elimination of numerous commonly held explanations for the Crisis. The authors' alternative theory, "diagnostic expectations", is interesting. The book is repetitive and unnecessarily lengthy in discussing it. A reader need be comfortable with mathematical economics but a high level of expertise is not required.
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