The End of (Behavioral) Finance

I’m tired of behavioral finance. Too much of it has become a sort of socio-psychological financial freakshow,  the past decade’s version of chaos theory. That part of behavioral finance can go away now.

Let’s be specific and empirical. For all their anarchic chops, which behavioral finance academics called the credit crisis? You can certainly argue Benoit Mandelbrot did, but it wasn’t with any specificity, and, more importantly, I wouldn’t call Mandelbrot a behavioral finance sort in any orthodox sense.

A different test. How did orthodox behavioral models do during the credit crisis? Richard Thaler’s funds, near as I can tell, all underperformed the market (see here and here and here).Explanatory power aside, that’s not much support for the practical utility of the models.

Sure, we can now tell lots of good stories – availability heuristic! hindsight bias! rational inattention ! etc. — but what was the real and measurable contribution of behavioral finance to ameliorating the credit crisis? Tell me, because I don’t know. (Feel free to argue that it’s still too early, even if I think that’s over-charitable.)

So, enough already. We get it. People are crazy. Efficient market theory is silly and, in the limit, outright dangerous. That is important to beat into people’s heads. Granted, EMT doesn’t work badly when it doesn’t matter, but it blows up when you need it most, which makes it sort of like a water-soluble flood barrier. Efficient market theory isn’t much of a theory, or particularly efficient, or have anything useful to do with most markets in which humans trade. Kill it.

What now? Well, behavioral finance gets pulled into finance (whatever that is anymore, and that’s a bigger subject); and much of the "oooh, look at the silly humans" behavioral stuff stops selling books or getting articles published. Then that’s it. We just have finance again — and it’s as generally ex post and useless as ever. But, having been largely taken over by behavioral finance, at least financial academics will tell better stories.

[Update] Hey, it looks like behavioral finance academic Richard Thaler agrees with me.

Related posts:

  1. Fireman Mortality, Behavioral Finance, and the Conjunction Fallacy
  2. linkfest 02/19/08: Behavioral Books, Grantham, Credit Cards, etc.
  3. How Yahoo Finance Begat Google Finance
  4. A Brief Guide to Fixing Finance
  5. Structured Finance Slides from Hudson Institute