The Financial Crisis as a Symbol of the Failure of Academic Finance? (A Methodological Digression)

6 Pages Posted: 24 Sep 2009

See all articles by Hans J. Blommestein

Hans J. Blommestein

Vivid Economics; Organization for Economic Co-Operation and Development (OECD); Tilburg University - Center and Faculty of Economics and Business Administration

Date Written: September 23, 2009

Abstract

The failure of academic finance can be considered one of the symbols of the financial crisis. Two important underlying reasons why academic finance models systematically fail to account for real-world phenomena follow directly from two conventions: (a) treating economics not as a 'true' social science (but as a branch of applied mathematics inspired by the methodology of classical physics); and (b) using economic models as if the empirical content of economic theories is not very low. Failure to understand and appreciate the inherent weaknesses of these 'conventions' had fatal consequences for the use and interpretation of key academic finance concepts and models by market practitioners and policymakers. Theoretical constructs such as the efficient markets hypothesis, rational expectations, and market completeness were too often treated as intellectual dogmas instead of (parts of) falsifiable hypotheses. The situation of capture via dominant intellectual dogmas of policymakers, investors, and business managers was made worse by sins of omission - the failure of academics to communicate the limitations of their models and to warn against (potential) misuses of their research - and sins of commission - introducing (often implicitly) ideological or biased features in research programs Hence, the deeper problem with finance concepts such as the 'efficient markets hypothesis' and 'ratex theory' is not that they are based on assumptions that are considered as not being 'realistic'. The real issue at stake with academic finance is not a quarrel about the validity of the assumption of rational behavior but the inherent semantical insufficiency of economic theories that implies a low empirical content (and a high degree of specification uncertainty). This perspective makes the scientific approach advocated by Friedman and others less straightforward. In addition, there is wide-spread failure to incorporate the key implications of economics as a social science. As response to these 'weaknesses' and challenges, five suggested principles or guidelines for future research programmes are outlined.

Keywords: risk management, academic thought, market efficiency, financial markets, financial crises, efficient market hypothesis

JEL Classification: G01, G12, G14, G2

Suggested Citation

Blommestein, Hans J., The Financial Crisis as a Symbol of the Failure of Academic Finance? (A Methodological Digression) (September 23, 2009). Available at SSRN: https://ssrn.com/abstract=1477399 or http://dx.doi.org/10.2139/ssrn.1477399

Hans J. Blommestein (Contact Author)

Vivid Economics

160 Euston Road
Grafton Place
London, NW1 2DX
United Kingdom

Organization for Economic Co-Operation and Development (OECD) ( email )

2 rue Andre Pascal
Paris Cedex 16, 75775
France

Tilburg University - Center and Faculty of Economics and Business Administration ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands

Register to save articles to
your library

Register

Paper statistics

Downloads
1,009
Abstract Views
5,929
rank
21,777
PlumX Metrics