Beyond Mechanical Markets: Asset Price Swings, Risk, and the Role of the State

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Princeton University Press, Feb 7, 2011 - Business & Economics - 288 pages
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In the wake of the global financial crisis that began in 2007, faith in the rationality of markets has lost ground to a new faith in their irrationality. The problem, Roman Frydman and Michael Goldberg argue, is that both the rational and behavioral theories of the market rest on the same fatal assumption--that markets act mechanically and economic change is fully predictable. In Beyond Mechanical Markets, Frydman and Goldberg show how the failure to abandon this assumption hinders our understanding of how markets work, why price swings help allocate capital to worthy companies, and what role government can and can't play.

The financial crisis, Frydman and Goldberg argue, was made more likely, if not inevitable, by contemporary economic theory, yet its core tenets remain unchanged today. In response, the authors show how imperfect knowledge economics, an approach they pioneered, provides a better understanding of markets and the financial crisis. Frydman and Goldberg deliver a withering critique of the widely accepted view that the boom in equity prices that ended in 2007 was a bubble fueled by herd psychology. They argue, instead, that price swings are driven by individuals' ever-imperfect interpretations of the significance of economic fundamentals for future prices and risk. Because swings are at the heart of a dynamic economy, reforms should aim only to curb their excesses.

Showing why we are being dangerously led astray by thinking of markets as predictably rational or irrational, Beyond Mechanical Markets presents a powerful challenge to conventional economic wisdom that we can't afford to ignore.

 

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Contents

What Went Wrong and What We Can Do about It
1
Assuming Away What Matters Most
2
The Imperfect Knowledge Alternative
6
Fishermen and Financial Markets
7
The Survival of the Rational Market Myth
8
Opening Economics and Finance to Nonroutine Change and Imperfect Knowledge
11
Imperfect Knowledge Economics and Its Implications
12
A New Understanding of AssetPrice Swings Risk and the Role of the State
14
Castles in the Air The Efficient Market Hypothesis
81
The Fable of Price Swings as Bubbles
103
An Alternative
115
Keynes and Fundamentals
117
Speculation and the Allocative Performance of Financial Markets
149
Fundamentals and Psychology in Price Swings
163
Bounded Instability Linking Risk and AssetPrice Swings
175
Contingency and Markets
195

The Critique
19
The Invention of Mechanical Markets
21
The Folly of Fully Predetermined History
41
The Orwellian World of Rational Expectations
55
The Figment of the Rational Market
71
Restoring the MarketState Balance
217
Epilogue
249
References
257
Index
273
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About the author (2011)

Roman Frydman is professor of economics at New York University. Michael D. Goldberg is the Roland H. O'Neal Professor at the University of New Hampshire. They are the coauthors of "Imperfect Knowledge Economics" (Princeton).

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