A Flaw in the Model… That Defines How the World Works

A Flaw in the Model… That Defines How the World Works

The authors of this paper claim that modeling financial markets based on probability theory is a severe systematic mistake that led to the global financial crisis. They argue that the crisis was not just the result of risk managers using outdated financial data, but that the employed efficiency model -- also referred to as the stochastic model -- is basically flawed. In an exemplary way, the analysis proves that this model is unable to account for interactions between market participants, neglects strategic interdependences, and hence leads to erroneous solutions. The central message is that the existing efficiency model should be replaced by an approach using agent-based scenario analysis.

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Bibliographic Details
Main Authors: Bieta, Volker, Milde, Hellmuth, Weber, Nadine
Language:English
Published: 2010-12-01
Subjects:ACCOUNTING, AGENCY PROBLEMS, AMOUNT OF CAPITAL, ASYMMETRIES OF INFORMATION, BANKING INDUSTRY, BANKING SECTOR, BENEFICIARY, CASH FLOW, CASH FLOWS, COLLATERAL, COLLATERALS, CONFLICTS OF INTEREST, CORPORATE FINANCE, CREDIT CONTRACT, CREDITOR, DEBT, DEBT FINANCING, DEBTOR, DECISION MAKING, DERIVATIVE, DERIVATIVES, ECONOMICS, EFFICIENT MARKET, EFFICIENT OUTCOMES, EQUITY FINANCING, FEDERAL REGULATORS, FEDERAL RESERVE, FEDERAL RESERVE SYSTEM, FINANCIAL ASSET, FINANCIAL ASSETS, FINANCIAL CRISIS, FINANCIAL DATA, FINANCIAL INSTRUMENTS, FINANCIAL MARKET, FINANCIAL MARKETS, FREE MARKETS, FUTURE CASH FLOWS, GAME THEORY, GOVERNMENT REFORM, HIGH INTEREST RATE, INFORMATION ASYMMETRY, INFORMATIONAL ASYMMETRY, INTEREST RATE, INTEREST RATES, INTERNATIONAL BANK, LOW INTEREST RATE, MARKET PARTICIPANT, MARKET PARTICIPANTS, MARKET PRICES, MATURITY, NASH EQUILIBRIUM, PERFECT COMPETITION, PERFECT MARKETS, PORTFOLIO, PRICE TAKERS, RANDOM WALK, REAL ESTATE, RESOURCE MOBILIZATION, RISK NEUTRAL, STATISTICAL DATA, SUBVENTIONS, WEALTH,
Online Access:http://www-wds.worldbank.org/external/default/main?menuPK=64187510&pagePK=64193027&piPK=64187937&theSitePK=523679&menuPK=64187510&searchMenuPK=64187283&siteName=WDS&entityID=000158349_20101208092950
https://hdl.handle.net/10986/3980
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Summary:The authors of this paper claim that modeling financial markets based on probability theory is a severe systematic mistake that led to the global financial crisis. They argue that the crisis was not just the result of risk managers using outdated financial data, but that the employed efficiency model -- also referred to as the stochastic model -- is basically flawed. In an exemplary way, the analysis proves that this model is unable to account for interactions between market participants, neglects strategic interdependences, and hence leads to erroneous solutions. The central message is that the existing efficiency model should be replaced by an approach using agent-based scenario analysis.

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