>
>
>>
>> On Sat, 29 Dec 2001, Juan Jose Barrios wrote:
>>
>>> If you have not done it already, I suggest (sorry Doug!! :-))) to
> read
>>> what Paul Davidson has to say on Global Financial Architecture...
>>
>> Is there any particular work you'd recommend?
>>
>> Michael
>>
> =================
>
> < http://econ.bus.utk.edu/davidsonextra/Davidson.html >
>
> Ian
>
"The ergodic axiom is one of three axioms that Keynes rejected when he emphasized the uncertainty that surrounds future outcomes. Keynes's description of uncertainty matches technically what mathematical statisticians call a nonergodic stochastic system. In Keynes's LPT [Liquidity Preference Theory] (1936, p. 161-3), the explanation of the long-run persistent existence of self-interested speculators in financial markets makes sense only if one assumes that market participants 'know' that it is impossible to calculate any reliable mathematical based expectation of gain calculated in accordance with existing probabilities. Or as Nobel laureate Hicks (1979, p. vii) put it: "One must assume that people in one's model do not know what is going to happen. And know they do not know what is going to happen. As in history!" Although in his published papers using nonstochastic modeling, Hicks [1979, p.113n] associated uncertainty and Keynes's liquidity analysis with a violation of the ordering axiom, in a private letter to me, he indicated that he should have labeled his 'own point of view as nonergodic'(13).
"In other words, if the economic system is nonergodic, then today's (presumed to exist) objective probability conditional distribution is not a reliable actuarial guide to the future. Had Scholes and Merton understood this The General Theory conception of an uncertain future before they won their Nobel Prize, they and their partners in Long Term Capital Management hedge fund would not have become de facto wards of the State in 1998. As Jamie Galbraith (1998), stated the fact that Merton and Scholes 'may soon seek the protection of the personal bankruptcy laws is almost besides the point; the intellectual bankruptcy of the [EMT] economics underlying their actions is already complete'." (Paul Davidson, "IS A PLUMBER OR A NEW FINANCIAL ARCHITECT NEEDED TO END GLOBAL INTERNATIONAL LIQUIDITY PROBLEMS?" <http://econ.bus.utk.edu/davidsonextra/plumber.fnl.htm>)
If Keynes assumes that "market participants 'know' that it is impossible to calculate any reliable mathematical based expectation of gain calculated in accordance with existing probabilities," how can he account for financial markets with significant participation by individuals like Merton and Scholes who don't 'know' this.
According to Roger Lowenstein, Merton and Scholes were not alone.
"by the 1990s, this approach [LTCM's 'Risk is a function of volatility. These things are quantifiable.'] had permeated most of Wall Street. Trading rooms had adopted the academics' faith in numeric certainties; risk managers at banks monitored volatilities as though they contained the Holy Grail. A senior executive at J.P. Morgan, when asked how he defined risk, breezily replied, 'As volatility around the mean.' The conceit of modern Wall Street was that the closing prices printed in each day's Wall Street Journal were as reliable and predictive about the future as the actuarial tables of life insurance companies or the known and certain odds in shooting craps. And the conceit stemmed largely from Merton and Scholes. Every investment bank, every trading floor on Wall Street was staffed by young, intelligent Ph.D.s who had studied under Merton, Scholes, or their disciples. The same firms that spent tens of millions of dollars per year on expensive research analysts - i.e., stock pickers - staffed their trading desks with finance majors who put capital at risk on the assumption that the market was efficient, meaning that stock prices were ever correct and therefore that stock picking was a fraud." (Lowenstein, When Genius Failed, pp. 24-5)
There is also the question as to why, in a world assumed to be made up of people who "know they do not know what is going to happen," Nobel Prizes are being awarded for work that assumes people "know what is going to happen."
In fact, however, Keynes assumes no such thing.
"the vast majority of those who are concerned with the buying and selling of securities know almost nothing whatever about what they are doing. They do not possess even the rudiments of what is required for a valid judgment, and are the prey of hopes and fears easily aroused by transient events and as easily dispelled. This is one of the odd characteristics of the capitalist system under which we live, which, when we are dealing with the real world, is not to be overlooked." (Keynes, Treatise on Money, Collected Writings, vol. VI, p. 323)
He treats the inappropriate mathematics as an obsessional way of psychologically denying the uncertainty and by this means avoiding the intolerable anxiety conscious awareness of it would provoke.
"as living and moving being, we are forced to act. Peace and comfort of mind require that we should hide from ourselves how little we foresee. Yet we must be guided by some hypothesis. We tend, therefore, to substitute for the knowledge which is unattainable certain conventions, the chief of which is to assume, contrary to all likelihood, that the future will resemble the past. That is how we act in practice." (vol. XIV, p. 124)
"the necessity for action and for decision compels us as practical men to do our best to overlook this awkward fact [that 'we simply do not know'] and to behave exactly as we should if we had behind us a good Benthamite calculation of a series of prospective advantages and disadvantages, each multiplied by its appropriate probability, waiting to be summed." (vol. XIV, p. 114)
Ted Winslow