I got my hands on this excellent "opinion paper" entitled "The Financial Crisis and the Systemic Failure of Academic Economics" by eight well known economists (Dahlem report). The paper outlines what went wrong with economics and finance in retrospect to the current crisis, and track it back (kindly said) to the failure of economics to address the questions that are most relevant to the society and not to make the shortcomings of its models clear.
"Many of the financial economists who developed the theoretical models upon which the modern financial structure is built were well aware of the strong and highly unrealistic restrictions imposed on their models to assure stability. Yet, financial economists gave little warning to the public about the fragility of their models; even as they saw individuals and businesses build a financial system based on their work."
The authors criticize heavily current representative agent economic models and hope that more efforts are put e.g. in network theory and agent based modeling.
"For example, the recent surge of research in network theory has received relatively scarce attention in economics. Given the established curriculum of economic programs, an economist would find it much more tractable to study adultery as a dynamic optimization problem of a representative husband, and derive the optimal time path of marital infidelity (and publish his exercise) rather than investigating financial flows in the banking sector within a network theory framework. This is more than unfortunate in view of the network aspects of interbank linkages that have become apparent during the current crisis."
I have collected a repository of such empirical research here. As is visible in the list, this work has already started at some central banks – as suggested in the report:
"We believe that it will be necessary for supervisory authorities to develop a perspective on the network aspects of the financial system, collect appropriate data, define measures of connectivity and perform macro stress testing at the system level. In this way, new measures of financial fragility would be obtained."
This entry was posted in News, Research. Bookmark the
permalink. Comments are closed, but you can leave a trackback:
Trackback URL.
The Financial Crisis and the Systemic Failure of Academic Economics
I got my hands on this excellent "opinion paper" entitled "The Financial Crisis and the Systemic Failure of Academic Economics" by eight well known economists (Dahlem report). The paper outlines what went wrong with economics and finance in retrospect to the current crisis, and track it back (kindly said) to the failure of economics to address the questions that are most relevant to the society and not to make the shortcomings of its models clear.
"Many of the financial economists who developed the theoretical models upon which the modern financial structure is built were well aware of the strong and highly unrealistic restrictions imposed on their models to assure stability. Yet, financial economists gave little warning to the public about the fragility of their models; even as they saw individuals and businesses build a financial system based on their work."
The authors criticize heavily current representative agent economic models and hope that more efforts are put e.g. in network theory and agent based modeling.
"For example, the recent surge of research in network theory has received relatively scarce attention in economics. Given the established curriculum of economic programs, an economist would find it much more tractable to study adultery as a dynamic optimization problem of a representative husband, and derive the optimal time path of marital infidelity (and publish his exercise) rather than investigating financial flows in the banking sector within a network theory framework. This is more than unfortunate in view of the network aspects of interbank linkages that have become apparent during the current crisis."
I have collected a repository of such empirical research here. As is visible in the list, this work has already started at some central banks – as suggested in the report:
"We believe that it will be necessary for supervisory authorities to develop a perspective on the network aspects of the financial system, collect appropriate data, define measures of connectivity and perform macro stress testing at the system level. In this way, new measures of financial fragility would be obtained."