A bit more than a year ago, I was reminiscing about my interactions with the investor relations departments of companies around earnings season:
“The IR teams themselves had some hilariously pathological incentives … they were to a large extent judged on the objective performance measure of whether the share price spiked upward or downward on the results day.
But, of course, the results day move was largely determined by whether the lousy results were better or worse than expectations. Consequently, the investor relations department had the incentive to spend the entire rest of the quarter talking to analysts like me saying “it’s awful, it’s terrible, it’s so goddamn bad”, so that when the results were merely a bit lousy, we had to upgrade. I played this stupid game for the best part of a decade, would you believe, and even won a couple of stupid prizes for doing so.
The game is still going on, according to Bryce Elder at Alphaville, and it appears to have got significantly more pathological in the last decade. The average “beat” of expectations is now often quite a bit smaller than the extent to which the forecasts got talked down in the first place.
I think this might be another one that we can blame on the business schools. Specifically, on the role of MBA finance classes which I wrote a bit about in “The Unaccountability Machine”, as incredibly efficient transmitters of ideology in the guise of objective science. It’s just that in this case, unlike the efficient markets hypothesis and the leveraged buyout boom, things have gone completely pathological, with a result that nobody at all wanted.
One of the first, and most important things you learn in an introductory class in empirical finance is the “event study”. It’s basically a natural experiment on share prices. You pick a date of an event, download the price dataset, clean it up for stock splits, dividends and the like and then do a test to see if the price move on the date of your event is statistically significant and has the predicted sign. Group a bunch of them together and you can answer questions like “does the stock market like mergers and acquisitions?” or “do dividend changes matter?”. Take them one by one and you can, maybe, answer questions like “did the market respect that CEO or did the price go up when he resigned?” or “was that product launch a success or a failure?”. The great advantage they have is that the actual statistics is really easy (it’s usually just a t-test), so you can drag MBA students through it even if they really signed up for the course because they wanted to do the “Leadership” modules.
The pathology, I think, comes in with the second group of examples I suggested above. If you have to do a bunch of event studies (which you usually do have to do as part of your MBA coursework), then you get really used to identifying the question “what does the market think?” with the statistical significance of the excess abnormal returns during a short time window. Or, once you’ve left business school and started work again, the “results day pop”.
Financial theory has a very strong tendency to drive financial practice – Donald McKenzie’s “An Engine Not A Camera” is a fantastic sociological and historical study of the way that modern derivatives markets, their institutions and even the governing law were shaped by advances in modelling and theory. But I’ve argued in the past (1, 2, 3, 4) that misunderstood theory is often more influential than correctly understood theory. I think that the event study in empirical finance has become, unintentionally, “antiperformative” in McKenzie’s sense with respect to earnings results – it has changed reality in a way that makes it no longer a useful measurement of anything.
I think the efficient market hypothesis is also to be viewed as a pathogen, a sort of financial Creuzfeld-Jacob Syndrome
"misunderstood theory is often more influential than correctly understood theory"
Most mathematicians would describe themselves as "Platonists". By this, they don't mean a form of Platonism that would be recognized by Plato - you can't settle a question in the philosophy of mathematics by appeal to authority - but just mathematical Realism: mathematical concepts and structures are discovered, not invented. They have 1st-order existence in some temporally unbounded abstract plane.
What about mathematical structures that are mutually exclusive? Joel David Hamkins points out that this is uncontroversial when it comes to geometry; few mathematicians would deny that both Euclid's and Riemann's geometries are valid mathematical structures, even though they make contradictory assumptions. So if you are committed to mathematical Platonism, you are committed to the idea that these incompatible structures live amicably together in the abstract plane.
But when it comes to set theory, things get more controversial. There is a thicket of set theoretic axioms you can accept or reject with far-reaching consequences (e.g. axiom of choice, continuum hypothesis, various large cardinal axioms, etc.) Hamkins thinks that this is no different in principle from geometry and that you ought to accept the Reality of all consistent set theories. He calls this "plenitudinous Platonism".
That seems reasonable enough to me, but many set theorists do not agree; the reason is that they think that mathematical concepts can be "true" in an absolute sense outside the relative truth ("soundness") of formal axiomatic systems. They seek the One True Set Theory, and therefore deny the reality of the pretenders. (One of these set theorists is Hamkins' thesis advisor Hugh Woodin, so, you know, some tension there.)
But I think that on the contrary, Hamkins doesn't go far enough. I see no reason why only true or sound mathematical concepts should be Real (and I foresee an endless forest of difficulties if this view were taken seriously, as various "eternal" concepts wink in and out of existence every time we change our minds.) Every erroneous and contradictory concept, every dumb mistake, ought to have the same ontological status as the true, sound, smart ones. And I think that by a sort of Anna Karenina principle, the abstract mathematical plane ought to be overwhelmingly populated by these mistakes.