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Underestimation of Wildness?

April 29, 2010 • Posted in Animal Spirits, Big Ideas

In the opening paragraphs of his April 2010 article entitled “Traditional vs. Behavioral Finance”, Robert Bloomfield handicaps his subject contest as follows:

“The traditional finance researcher sees financial settings populated not by the error-prone and emotional Homo sapiens, but by the awesome Homo economicus. The latter makes perfectly rational decisions, applies unlimited processing power to any available information, and holds preferences well-described by standard expected utility theory. Anyone with a spouse, child, boss, or modicum of self-insight knows that the assumption of Homo economicus is false.”

Might some other frame of reference relieve the asserted asymmetry in self-insight and more equally burden the contestants, rationalist and irrationalist?

Could it be that…

Evolutionary forces have formed the range and likelihoods of human responses to be largely rational (effectively adaptive) for reasonably expected outcome distributions?

Reasonably expected outcome distributions for financial markets are not distinct from those for evolutionary experience, and perceived wildness in investor behavior stems not from “irrationality” but from market models with materially unrealistic outcome distributions?

In other words, reasonably expected market outcome distributions are wilder than those posited in “traditional” finance models.

The models of “behavioral” finance delineating rational and irrational behavior sets address this underestimation of wildness with inelegant patches.

For some related thoughts, see “Different Paths to the Same (Disconcerting) Destination?”, “The Entropic Markets Hypothesis” and “The Adaptive Markets Hypothesis”.

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