‘Financial engineering’ –a costly pseudoscientific mistake

6 July, 2016 at 16:09 | Posted in Economics | 2 Comments

7-3-Montecristo-Magazine-Autumn-2014-artifacts_page_1_image_0003Note that the economist Robert Lucas dealt a blow to econometrics by arguing that if people were rational then their rationality would cause them to figure out predictable patterns from the past and adapt, so that past information would be completely useless for predicting the future … If rational traders detect a pattern of stocks rising on Mondays, then, immediately such a pattern becomes detectable, it would be ironed out by people buying on Friday in anticipation of such an effect. There is no point searching for patterns
that are available to everyone with a brokerage account; once detected,
they would be ironed out …

You can disguise charlatanism under the weight of equations, and nobody can catch you since there is no such thing as a controlled experiment … The practice of ‘financial engineering’ came along with massive doses of pseudoscience. Practitioners of these methods measure risks, using the tool of past history as an indication of the future. We will just say at this point that the mere possibility of the distributions not being stationary makes the entire concept seem like a costly (perhaps very costly) mistake.



  1. “A further implication of all this is that economic science is now viewed as no longer in contradiction with the pursuit of desired change, but rather is recognised as essential to it. It is certainly an insight of the ‘Lucas critique’ that adjustments in social policy can affect beliefs which in turn affect actions and so outcomes. In attempting to sustain econometric practice in the light of this critique, however, econometricians, by postu lating rational expectations and thereby event-relationships that are invariant to changes in policy rules, have been forced to reject the notion of efficacious policy action, viewing it as effectively illusory. In similar fashion they have found it difficult to sustain any meaningful role for policy advice by economists or indeed any possibility of choices being made by individual agents generally (Reder, 1982). In short, an acceptance of the feasibility of forecasting correctly and unconditionally entails a denial of the reality of human beings making any part of their own history. Once the superior adequacy of the transcendental realist account is recognised, however, no such difficulties or denials arise.”

    From “The ‘Lucas critique’: a generalization,” Tony Lawson in
    Cambridge Journal of Economics, Vol. 19, No. 2 (April 1995), pp. 257-276

    • Great quote!

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