From Dissonance to Resonance: Cognitive Interdependence in Quantitative Finance

59 Pages Posted: 16 Oct 2008 Last revised: 29 Jul 2011

Daniel Beunza

London School of Economics & Political Science (LSE) - Department of Management

David Stark

Columbia University

Date Written: July 27, 2011

Abstract

This study explores the elusive social dimension of quantitative finance. We conducted three years of observations in the derivatives trading room of a major investment bank. We found that traders use models to translate stock prices into estimates of what their rivals think. Traders use these estimates to look out for possible errors in their own models. We found that this practice, reflexive modeling, enhances returns by turning prices into a vehicle for distributed cognition. But it also induces a dangerous form of cognitive interdependence: when enough traders overlook a key issue, their positions give misplaced reassurance to those traders that think similarly, disrupting their reflexive processes. In cases lacking diversity, dissonance thus gives way to resonance. Our analysis demonstrates how practices born in caution can lead to overconfidence and collective failure. We contribute to economic sociology by developing a socio-technical account that grapples with the new forms of sociality introduced by financial models – dissembedded yet entangled; anonymous yet collective; impersonal yet, nevertheless, emphatically social.

Keywords: Merger Arbitrage, Systemic Risk, Model

JEL Classification: C51, G10

Suggested Citation

Beunza, Daniel and Stark, David, From Dissonance to Resonance: Cognitive Interdependence in Quantitative Finance (July 27, 2011). Available at SSRN: https://ssrn.com/abstract=1285054 or http://dx.doi.org/10.2139/ssrn.1285054

Daniel Beunza (Contact Author)

London School of Economics & Political Science (LSE) - Department of Management ( email )

United Kingdom
02071061146 (Phone)

David Stark

Columbia University ( email )

3022 Broadway
New York, NY 10027
United States

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