Management Online REview

10 March 2010 | Home

ISSN 1996-3300

Finance

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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.

Examination of NZ Finance Company Failures: The Role of Corporate Governance

W.R. Wilson

Lawrence C. Rose

J.F. Pinfold

Recently any difficulty a financial institution found itself in seems to have been blamed on the global financial crisis. This paper, employing forensic case study analysis of finance companies in New Zealand rebuts this excuse. Instead, it is argued the large number of failures in New Zealand finance companies in the last four years was due to a failure of regulation and corporate governance, occurring well ahead of the global financial crisis.

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

Hans J Blommestein

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

Economists' Hubris - The Case of Asset Pricing

Shahin Shojai

George Feiger

This is the second in a series of articles that examines the practical applications of economic thought - its focus is on the most fundamental aspects of finance theory, namely asset pricing. We discuss the major pricing models developed during the past five decades and critically examine their practical applications. Sadly, the results are not very encouraging. As with other academic economic disciplines, the gap between what is taught about the markets and what actually takes place is quite large, a gap in no way mitigated by the behavioralist arm of the subject. The seminal works of Sharpe and Lintner have provided us with a sound foundation upon which to build realistic pricing models, but unfortunately the unwavering acceptance of these models has results in research that merely cements their acceptance, discouraging an examination of how those pricing models could be adapted to suit the practical world.

From Behavioural to Emotional Corporate Finance: A New Research Direction

Richard Fairchild

This paper extends the work of Taffler and Tuckett (2005) on Emotional Finance by proposing a new development, namely Emotional Corporate Finance. We argue that managers view their projects as phantastic objects and develop a formal approach that considers the effects of managerial phantasy on the investment appraisal decision, project performance and managerial entrapment in a losing project.

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