Posted on September 19, 2009 by admin

Perhaps the trouble with finance economics is also the trouble with any sort of economic field of study; these different schools of thought refuse to consider others’ ideas. There are financial and behavioral economics professors. There are micro and macro economics theorists. The truth lies somewhere in-between these disparate ideas about how large and small-scale economies function and what variables affect them the most.

Nobel prize winning economist Myron Scholes argues that it’s not the models of financial economics that failed us here, but rather, the improper practices of Wall Street and the legislators who allowed them to run too far. Financial firms plugged in data reflecting “a view of the world that was far more benign than it was reasonable to take, emphasizing recent inputs over more historic numbers,” explained Scholes. He said a lot of the models were dead-on and most derivatives and securities performed exactly as predicted, but a few of the exceptions proved disastrous. Since 1998, Scholes had been warning his colleagues about the risk that liquid markets could dry up suddenly and without warning and that individual decisions made in the financial sector could have a great impact on the larger economy as a whole.

One of the most interesting findings pertaining to behavioral and finance economics is how a person reacts to loss. Economics research suggests that, during periods of loss, some investors can become “extremely irrationally risk-averse,” which leads them to take exaggerated reactions. For instance, when the real estate bubble burst, which was long expected as a natural progression, many investors hastily pulled all their money out of the stock market, which caused widespread panic and a domino effect of other investors who did the same. The question economists must ask now is how can they restore consumer confidence and keep it?