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Economists' Hubris - The Case of Equity Asset Management

Shojai, S.

Feiger, G

Kumar, R
In this, the fourth article in the economists’ hubris paper series we look at the contributions of academic thought to the field of asset management. We find that while the theoretical aspects of the modern portfolio theory are valuable they offer little insight into how the asset management industry actually operates, how its executives are compensated, and how their performances are measured. We find that very few, if any, portfolio managers look for the efficiency frontier in their asset allocation processes, mainly because it is almost impossible to locate in reality, and base their decisions on a combination of gut feelings and analyst recommendations. We also find that the performance evaluation methodologies used are simply unable to provide investors with the necessary tools to compare portfolio managers’ performances in any meaningful way. We suggest a novel way of evaluating manager performance which compares a manager against himself, as suggested by Lord Myners. Using the concept of inertia, an asset manager’s end of period performance is compared to the performance of his/her portfolio assuming his/her initial portfolio had been held, without transactions, during this period. We believe that this will provide clients with a more reliable performance comparison tool and might prevent unnecessary trading of portfolios. Finally, given that the performance evaluation models simply fail in practice, we suggest that accusing investors who look for raw returns when deciding who to invest their assets with is simply unfair.

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

Blommestein, H.J.
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 notthat 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 a response to these ‘weaknesses’ and challenges, five suggested principles or guidelines for future research programs are outlined.

The Future for Financial Risk Management

Tapiero, Charles S.
The financial crisis of 2008 revealed all we already knew - liquidity matters greatly, the future may be unpredictable, non-transparency, complexity and ambiguity contrived with greed to derail financial sustainability, financial models are not efficient. These revelations increased our awareness that our financial expectations can and do falter. The awareness may alter the financial regulatory environment, financial markets in general, our financial attitudes and beliefs and the future for financial risk management. This article assesses the future for financial risk management and also examines relevant essential concerns in meeting the challenges of an increasingly turbulent financial world.

The Biotechnology Cluster in San Diego: An Analysis of IPO Activity and Probability of Success for Firms

Munteanu, R.
The biotech cluster in San Diego is dominated by small firms, with approximately 73% of the firms employing between 1 to 49 employees. Among the main important sources of financing for the biotech companies are venture capital and initial public offerings. In spite of the aggregate increase in the number of firms and employees in the biotech cluster, there is a high degree of heterogeneity at the level of individual firms. This paper uses data on the firms that have initiated an IPO offering between 1990-2000, and analyzes how the probability of “success” for these firms depends on various firm’s characteristics. I use two “success” measures and the empirical results indicate that the probability of success is positively influenced by the number of employees and the IPO amount.

Economists' Hubris - The Case of Risk Management

Shojai, S

Feiger, G
In this, the third paper in the Economists’ Hubris series; we highlight the shortcomings of academic thought in developing models that can be used by financial institutions to institute effective enterprise-wide risk management systems and policies. We find that pretty much all of the models fail when put under intense scientific examinations and that we still have a long way to go before we can develop models that can indeed be effective. However, we find that irrespective of the models used, the simple fact that the current IT and operational infrastructures of banking institutions does not allow the management to obtain a holistic view of risk and the silos they sit within means that instituting an effective enterprise-wide risk management system is as of today nothing more than a panacea. The main worry is that it is not only academics who fail to realize this fact, practitioners also believe that these models work even without having a holistic view of the risks within their organizations. In fact, we can state that this is the first paper in which we highlight not only the hubris exhibited by economists but also the hubris of practitioners who still believe that they are able to accurately measure and manage the risk of the institutions they manage, monitor, or regulate.

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