Modern Financial Market Theory – A Critique Based on the Logic of Human Action

2021 ◽  
Vol 54 (3) ◽  
pp. 447-467
Author(s):  
Thorsten Polleit
Keyword(s):  
Decision Making ◽  
Financial Markets ◽  
Financial Market ◽  
Real World ◽  
Rational Expectation ◽  
Efficient Market Hypothesis ◽  
Human Action ◽  
Market Theory ◽  
Expectation Theory ◽  
Market Economics

The modern financial market theory (MFMT) – based on the efficient market hypothesis, rational expectation theory, and modern portfolio theory – has become the standard approach in financial market economics. In this article, the MFMT will be critically ­reviewed using the logic of human action (or: praxeology) as an epistemological meta­theory. It will be shown that the MFMT exhibits (praxeo-)logical deficiencies so that it cannot provide investors with well-founded decision-making support in real-world financial markets.

EFFICIENT MARKETS AND BEHAVIORAL FINANCE: A COMPREHENSIVE MULTIFRACTIONAL MODEL

2015 ◽  
Vol 18 (01n02) ◽  
pp. 1550001 ◽  
Author(s):  
SERGIO BIANCHI ◽  
ALEXANDRE PANTANELLA ◽  
AUGUSTO PIANESE
Keyword(s):  
Stochastic Model ◽  
Financial Markets ◽  
Financial Market ◽  
Behavioral Finance ◽  
Real World ◽  
Efficient Market Hypothesis ◽  
Efficient Markets ◽  
Living Matter ◽  
Psychological Phenomena ◽  
Special Cases

Real-world financial dynamics daily do challenge the credibility of the Efficient Market Hypothesis, the pillar of the whole martingale-based modern financial theory stating that at any time asset prices discount all past information. As a matter of fact, the empirical evidence accumulated so far indicates that current models cannot explain the complexity of financial market movements, to the extent that a strand of skeptical thought, the Behavioral Finance, has been booming. The question whether a model exists which is able to make consistent the two paradigms is a living matter that financial markets demand to address. The paper deals with a parsimonious stochastic model able to include as special cases both market efficiency and "psychological" phenomena such as the underreaction and the overreaction, peculiar features of the behavioral finance. The great readability of the model, its capability to agree the controversial results provided by literature on efficient markets and the simplicity of the financial intuition it offers are discussed.

Matchmakers and Markets

2020 ◽  
Author(s):  
Yi-Cheng Zhang
Keyword(s):  
Financial Markets ◽  
Policy Maker ◽  
Real World ◽  
World Economy ◽  
Market Theory ◽  
Wall Street ◽  
The Real ◽  
Information Intermediaries ◽  
Consumer Markets ◽  
High Street

In attempting to understand the bewildering complexity of consumer markets, financial markets, and beyond, traditional textbooks and theories will not help much. This book presents a new market theory in which information plays the most important role. Markets are portrayed with three categories of actor: consumers, businesses, and information intermediaries. The reader can determine his own role, and with analysis and examples from the real-world economy, new questions can be raised and individual conclusions drawn. The aim is to stimulate the reader’s own thinking, either as a consumer on the high street, an investor on Wall Street, a policy maker in a government armchair, or an entrepreneur dreaming of the next big opportunity. This book should also generate and inspire academic debates, as the claims and conclusions are often at odds with mainstream theory.

Principles for modelling financial markets

1996 ◽  
Vol 33 (03) ◽  
pp. 601-613 ◽  
Author(s):  
Eckhard Platen ◽  
Rolando Rebolledo
Keyword(s):  
Financial Markets ◽  
Financial Market ◽  
Real World ◽  
Market Model ◽  
Rate Of Return ◽  
Probability Measures ◽  
Market Clearing ◽  
The Difference ◽  
Risk Free Rate ◽  
Free Rate

The paper introduces an approach focused towards the modelling of dynamics of financial markets. It is based on the three principles of market clearing, exclusion of instantaneous arbitrage and minimization of increase of arbitrage information. The last principle is equivalent to the minimization of the difference between the risk neutral and the real world probability measures. The application of these principles allows us to identify various market parameters, e.g. the risk-free rate of return. The approach is demonstrated on a simple financial market model, for which the dynamics of a virtual risk-free rate of return can be explicitly computed.

scholarly journals Three Different Ways Synchronization can Cause Contagion in Financial Markets

2018 ◽  
Author(s):  
Jorgen Vitting Andersen ◽  
Naji Masaad
Keyword(s):  
Decision Making ◽  
Financial Markets ◽  
Financial Market ◽  
Change Blindness ◽  
Market Performance ◽  
Large Change ◽  
Trading Strategies ◽  
Fire Dynamics ◽  
Integrate And Fire ◽  
Human Decision

We introduce tools to capture the dynamics of three different pathways, in which the synchronization of human decision making could lead to turbulent periods and contagion phenomena in financial markets. The first pathway is caused when stock market indices, seen as a set of coupled integrate-and-fire oscillators, synchronize in frequency. The integrate-and-fire dynamics happens due to "change blindness", a trait in human decision making where people have the tendency to ignore small changes, but take action when a large change happens. The second pathway happens due to feedback mechanisms between market performance and the use of certain (decoupled) trading strategies. The third pathway occurs through the effects of communication and its impact on human decision making. A model is introduced in which financial market performance has an impact on decision making through communication between people. Conversely, the sentiment created via communication has an impact on financial market performance.

scholarly journals Martingales, Efficient Market Hypothesis and Kolmogorov’s Complexity Theory

2011 ◽  
Vol 2 (6) ◽  
pp. 252-258
Author(s):  
Amaresh Das
Keyword(s):  
Time Series ◽  
Financial Markets ◽  
Stock Returns ◽  
Complexity Theory ◽  
Efficient Market Hypothesis ◽  
Market Theory ◽  
Efficient Market ◽  
Price Changes ◽  
Efficient Market Theory ◽  
Theoretical Considerations

Efficient market theory states that financial markets can process information instantly. Empirical observations have challenged the stricter form of the efficient market hypothesis (EMH). These empirical observations and theoretical considerations show that price changes are difficult to predict if one starts from the time series of price changes. This paper provides an explanation in terms of algorithmic complexity theory of Kolmogorov that makes a clearer connection between the efficient market hypothesis and the unpredictable character of stock returns.

scholarly journals Stochastic representation decision theory: How probabilities and values are entangled dual characteristics in cognitive processes

PLoS ONE ◽  
2020 ◽  
Vol 15 (12) ◽  
pp. e0243661
Author(s):  
Giuseppe M. Ferro ◽  
Didier Sornette
Keyword(s):  
Decision Making ◽  
Decision Maker ◽  
Time Pressure ◽  
Rational Expectation ◽  
Weighting Function ◽  
Objective Probability ◽  
Decision Making Process ◽  
Stochastic Representation ◽  
Human Decision ◽  
Expectation Theory

Humans are notoriously bad at understanding probabilities, exhibiting a host of biases and distortions that are context dependent. This has serious consequences on how we assess risks and make decisions. Several theories have been developed to replace the normative rational expectation theory at the foundation of economics. These approaches essentially assume that (subjective) probabilities weight multiplicatively the utilities of the alternatives offered to the decision maker, although evidence suggest that probability weights and utilities are often not separable in the mind of the decision maker. In this context, we introduce a simple and efficient framework on how to describe the inherently probabilistic human decision-making process, based on a representation of the deliberation activity leading to a choice through stochastic processes, the simplest of which is a random walk. Our model leads naturally to the hypothesis that probabilities and utilities are entangled dual characteristics of the real human decision making process. It predicts the famous fourfold pattern of risk preferences. Through the analysis of choice probabilities, it is possible to identify two previously postulated features of prospect theory: the inverse S-shaped subjective probability as a function of the objective probability and risk-seeking behavior in the loss domain. It also predicts observed violations of stochastic dominance, while it does not when the dominance is “evident”. Extending the model to account for human finite deliberation time and the effect of time pressure on choice, it provides other sound predictions: inverse relation between choice probability and response time, preference reversal with time pressure, and an inverse double-S-shaped probability weighting function. Our theory, which offers many more predictions for future tests, has strong implications for psychology, economics and artificial intelligence.

Gender justice in financial markets

2017 ◽  
Author(s):  
Roseanne Russell ◽  
Charlotte Villiers
Keyword(s):  
Decision Making ◽  
Social Justice ◽  
Financial Markets ◽  
Financial Market ◽  
Business Case ◽  
Decision Makers ◽  
Gender Justice ◽  
Women Directors ◽  
Normative Foundation ◽  
The Subject

Financial markets have often been represented and treated as gender-neutral domains despite the consequences of their operation and the structure of their institutions being deeply gendered. In the post-financial crisis period the contribution of women to financial markets (whether as creditors, entrepreneurs, or consumers) has been the subject of intense interest. Particular attention has been paid to the identity of financial market decision-makers. A lack of women’s representation in the boardrooms of influential companies is considered problematic. In response, financial market actors have emphasized the “business case” for boardroom diversity. While the identity of corporate decision-makers is an important aspect of “gender-just” financial markets, the “business case” for reform lacks a secure theoretical and normative foundation. Instead, an alternative argument for women directors with a greater emphasis on social justice feminism is necessary if gender justice in financial market decision-making is realistically to be achieved.

scholarly journals Excessive self-confidence: The initiator of the irrational in behavioral finance

2020 ◽  
Vol 22 (2) ◽  
pp. 97-108
Author(s):  
Aleksandar Dogandžić ◽  
Nebojša Stošić ◽  
Sonja Dogandžić
Keyword(s):  
Decision Making ◽  
Financial Markets ◽  
Market Efficiency ◽  
Financial Market ◽  
Behavioral Finance ◽  
Decision Making Process ◽  
Self Confidence ◽  
Irrational Behavior ◽  
The Subject ◽  
Decision Making Behavior

The classical theory of financial markets is based on the decision-making process based on hypotheses about "market efficiency", which implies rational decisionmaking that always brings the expected results that can be predicted and calculated. However, practice shows that there are situations of irrational decision-making in the markets, the results of which are far from predictable and expected. We need to study these situations through Behavioral Finance, which allows us to monitor the results of irrational decision-making behavior, which we call anomalies. Most irrational decisions are based on excessive self-confidence, so it is the subject of necessary continuous research in order to clarify this segment of irrational behavior in the behavior of actors in the financial market and thus use it to achieve optimal effects.

Financial Markets

2020 ◽  
pp. 71-88
Author(s):  
Yi-Cheng Zhang
Keyword(s):  
Financial Markets ◽  
Financial Market ◽  
Market Theory ◽  
A Value ◽  
Investment Opportunities ◽  
The Common ◽  
Per Se ◽  
Financial Transactions ◽  
Role Of Information

Chapter 5 extends consumer market theory to finance, to examine the similarities and particularities of both types of market. The common feature is still the role of information, and financial markets are also about how to determine a financial products’ quality. We propose the market symbiosis hypothesis that portrays the role of financial markets in the general economy. We argue that although financial transactions do not create value per se, all players in the financial markets have a value-creation role in selecting outside investment opportunities. A well-functioning financial market can enable more quality investments to be funded and can stimulate their creation.

scholarly journals Financial Variables, Market Transactions, and Expectations as Functions of Risk

2019 ◽  
Vol 7 (4) ◽  
pp. 66
Author(s):  
Victor Olkhov
Keyword(s):  
Simple Model ◽  
Financial Markets ◽  
Financial Market ◽  
The Other ◽  
Density Functions ◽  
Market Theory ◽  
Financial Flows ◽  
Financial Variables ◽  
The Cost ◽  
Economic Domain

This paper develops methods and a framework of financial market theory. We model financial markets as a system of agents which perform market transactions with other agents under the action of numerous expectations. Agents’ expectations are formed of economic and financial variables, market transactions, the expectations of other agents, and other factors that impact financial markets. We use the risk ratings of agents as their coordinates and approximate a description of financial variables, market transactions, and expectations of numerous separate agents by density functions of aggregated agents in the economic domain. The motion of separate agents in the economic domain due to a change of agents’ risk rating produces collective financial flows of variables, transactions, and expectations. We derive equations on collective financial variables, market transactions, expectations, and their flows in the economic domain. These flows define the evolution of financial markets. As an example, we present a simple model with linear dependence between disturbances of volume and the cost of transactions on one hand, and disturbances of expectations that determine transactions on the other hand. Our model describes harmonique oscillations of these disturbances with numerous frequencies and allows an explicit form for fluctuations of price and return to be derived. These relations show a direct dependence between price, return, and volume perturbations.

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