The Normative Foundation of Finance: How Misunderstanding the Role of Financial Theories Distorts the Way We Think About the Responsibility of Financial Economists

Abstract

The financial crisis has fuelled a heated debate about the responsibility of financial economists. Critics such as Paul Krugman, Robert Shiller or David Colander argue that financial economists have developed useless or even harmful theories. This is an important debate, but it suffers from the fact that the role of financial theories remains unclear. In this paper we enter the field of philosophy of science to clarify this issue. In particular we emphasize the research interests and the various philosophical assumptions of three alternative views on financial theories. We analyze the widespread positivistic conception of financial theories and contrast it with a postmodern perspective. We conclude that both positions have limitations. As an alternative, we outline a constructivist conception of financial theories. In the final section, we use these insights from philosophy of science to clarify the responsibility of financial economists. Financial economists have to critically reflect the problems in practice that need to be addressed and to keep their theories closely tied to these original problems. We show how, in the case of the “efficient market hypothesis,” the misunderstanding of the role of financial theories led financial economists to neglect this responsibility.

Keywords: financial models, financial crisis, theory of science, positivism, constructivism, responsibility of financial economists