ssrn-id1477399 - Journal of Financial Transformation The...

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Electronic copy available at: Journal of Financial Transformation Page 69 The financial crisis as a symbol of the failure of academic finance? (A methodological digression) Hans J. Blommestein 1 , PwC Professor of Finance, Tilburg University, The Netherlands 1 The views expressed are personal ones and do not represent the organizations with which the author is affiliated. Abstract 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 response to these „weaknesses‟ and challenges, five suggested principles or guidelines for future research programmes are outlined.
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Electronic copy available at: Journal of Financial Transformation Page 70 Implications of neglecting the nature and limitations of economics as a social science Can the financial crisis also be considered a symbol for the failure of academic finance 2 ? An affirmative answer can in my view be based on the reasoning that most research programs in academic finance, and economics more in general, have
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ssrn-id1477399 - Journal of Financial Transformation The...

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