I just had some argument with a PhD researcher about the value of behavioral models over the up-till-now traditional financial modeling. You see, behavioral finance is a growing field of financial science and came into prominence after the last catastrophic implosion of the global financial market. Obviously some greedy folks went berserk and all the fancy market models developed to understand them were obviously on vacation (read Fama, French, Sharpe, Markowitz, Merton Miller and a bunch of others. I can’t even imagine that some people actually got a Nobel for this type of rubbish. In a world where Obama can get a Nobel for Peace in anticipation of peace, anything can happen!).
From the behavioral finance people’s point of view, financial and capital models are crap and can’t model how the financial world will behave as it is based on what is called the rational model (players will behave according to expectation) but can’t understand the primordial human instincts (greed, fear, ego, etc.) which ultimately always upturn things.
This is actual bone of contention. We both agreed that the current models are capital BS but I believe that the financial and capital behavior can be modeled. What we don’t have now is enough attributes to put into the model to factor things in. Another thing is to redefine what a rational attribute is. Purchasing an equity based on PE ratio is a rational behavior but it doesn’t even rank as much as buying because of fear! Or why would the experts spend so much time wondering that the Weekend Effect is all about?
This is what luxury good purveyors have known for centuries, people don’t buy because a purchase makes sense, they buy for all manners of reasons and that is what we modeler need to figure out.
Can fear be modeled? Yeah! Same for herd behavior, for greed, for revenge, etc. What I dont know is if a smart dude is going to figure it out in a year, decade or century but I can put my bet on 2 decades out there. What do you think we are going to use all those powerful computers to do? Turn them into Precogs while the world reenact Minority Report. So between now and then, I will advice my fancy research to go find another job; behavioral finance career is about to hit a dead end.