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how economic sociology is different from behavioral finance

Daniel Beunza addresses the difference between economic sociology and behavioral finance in a new blog post.  Daniel provides an answer to the question of what makes them different, drawing of course on his own work in the social studies of finance. Both fields are interested in how market outcomes deviate from those you’d expect given the lens of the efficient market hypothesis, but Daniel asserts that behavioral finance looks to individual biases as a source of inefficiency while economic sociology focuses on the social conditions (e.g., technology) that cause deviations in pricing.

Although their perspectives are quite different, Daniel’s post reminded me of something Ezra Zuckerman wrote in his 2004 ASR paper on the structural incoherence of markets. In that paper’s conclusion, Ezra compares sociological accounts of markets to behavioral finance and draws a very similar conclusion. Here’s Ezra’s take:

My approach is thus not framed at the level of the individual decision-maker. Rather, I challenge the assumption made by the EMH that the social structural environment typical of financial markets always has the necessary features to support the highly sophisticated social learning necessary for incorrect models of valuation to be driven from the market. The question is, to what extent can a financial market be likened to a laboratory in which hypotheses about the meaning of economic news can be tested with experimental results that are immediate and clear to all concerned? (427-28)

The biggest difference between the two subfields is that economic sociology is much more interested in the “architecture of markets” while behavioral finance is still more or less interested in the limits of individual decision-making. As a test of this hypothesis, check out Lounsbury’s and Hirsch’s forthcoming volume about the sociology of the financial crisis. You won’t find many papers that talk about the irrational investor. Most of the papers are about institutional design. Ezra’s contribution to the volume follows his previous line of thought. Here’s an excerpt:

I argue that a sociological approach to regulating securities markets requires a clear stance on the relationship between price and value, one that combines (a) the contrarian thesis that there are objective criteria by which one can assess value more accurately than the current market price; (b) the constructionist thesis that prices are governed by commonly known beliefs that can vary substantially from the objective reality they purport to reflect; and (c) the realist thesis that the market comprises powerful mechanisms (arbitrage and learning) that, when working properly, close the gap between the contrarian’s private belief and common knowledge, thus producing reasonable prices. This intergrated “rationalist” perspective understands the real estate bubble as the product of institutional conditions that fostered pluralistic ignorance regarding the extent of bearish sentiment.

Written by brayden king

April 19, 2010 at 10:57 pm

12 Responses

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  1. Brayden — absolutely right to point out that Ezra’s and my view on behavioral finance are related. And it’s hardly a coincidence, given how much I appreciate his work. But I think sociologists should go further than declaring markets imperfect. Rather than a limited learning environment, modern markets are developed to the point of being shaped by the models themselves. The models are not (just) a faulty camera. They’re also an engine. This second part is what is most difficult for non-sociologists to grasp.

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    danielbeunza

    April 19, 2010 at 11:33 pm

  2. “…modern markets are developed to the point of being shaped by the models themselves…”

    Daniel: A naive and broad question, but, before the existence of these models and technologies — what shaped (even ‘created’) markets? I know performativity-type arguments emphasize the machinery, but we have market-like interactions and associated institutions well before the technologies that extant work focuses on (thus perhaps your emphasis on “modern”).

    And, back to the machinery of modern markets, might the models not just (attempt to) describe reality, but get objectively better over time and thus help improve things — do the models then perform, create or something else? Is there a way to capture progress? Are there objectively, ex ante, better models?

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    tf

    April 20, 2010 at 2:28 am

  3. @tf,

    I’m not Daniel but I’ll take a stab at answering your question “what shaped markets before the models?” Briefly, before today’s models, their were different models that shaped different (though not unrecognizable to modern eyes) markets. Mitchell’s “Rule of Experts” is a great book that discusses how the relatively modern models by which we understand and perform markets (again engine vs. camera) and “the economy” today were imposed on colonial-era Egypt. Reading it will give you a good idea of what existed before modern models (and in some places still exist today).

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    Justin Kraus

    April 20, 2010 at 4:06 am

  4. tf and Justin — tf’s questions are interesting, and come from a view of value as independent from the beliefs of market actors (“intrinsic value”). if that’s the case, we’re back to behavioral finance.

    my view (along with Justin’s) is that sociology is most distinct when stressing the ways in which value is not independent from the social context. one does not need to go rocket science on this. tools can be simple… e.g. the shape of an auction house matters.

    second, if you accept that models intervene rather than represent, then you face the question of what is a “good” model. certainly, accuracy (i.e. correspondence between model and market prices) cannot be the deciding factor.

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    danielbeunza

    April 20, 2010 at 8:06 am

  5. Right, the extent and forms of that independence and interdependence are indeed at question. Some things, however, just are — and that reality has a way of intervening and checking (not counter-performing) the models themselves as well.

    I just struggle with the fact that “goodness” and “better” even need quotation marks, wouldn’t that intuition then also apply to performativity program itself — perhaps it’s also a reality-independent game, how does it step outside itself?

    The performativity meta-tools and apparatus also deserve analytical scrutiny.

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    tf

    April 20, 2010 at 3:21 pm

  6. Prof. Beunza: I find it hard to disagree with the points made in your post. However this talk of “social context” versus “individual biases” seems to me very Durkheimian and appears to miss the point somewhat. Part of what I believe economic sociology should be focusing on is how the decisions of the individual actor are shaped by the different social contexts s/he is immersed in: the market, the institution, the enterprise, etc. In turn, those “contexts” are shaped by the behavior of individuals. In this sense, economic sociology is indeed concerned with the actor as a link between the micro and macro levels. So far, however, what I’ve read of the subfield seems to focus mostly on the macro level.

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    Guillermo

    April 20, 2010 at 4:07 pm

  7. Teppo — point well taken. but instead of having a generic/ideological conversation about the merits of performativity, I think it is far more interesting to consider whether it helps us better understand the case that the blog post and paper is about: the failed merger between GE and Honeywell.

    One interesting piece of evidence that models shaped prices in this instance was the fact that a prominent hedge fund, Atticus Global, was able to develop a trading strategy to exploit it. According to the Financial Times,

    “The reason for Atticus Global’s outperformance seems to have
    been its explicit acceptance that hedge fund flows influence
    markets (…) One of Atticus Global’s most successful recent trades was its contrarian position on General Electric’s proposed acquisition of Honeywell. Most risk arbitrage managers followed their usual strategy of going long the target, Honeywell, and short the buyer, GE, assuming that the spread between the two would close when the deal was finalised. However, Atticus Global shorted Honeywell and bought GE, making a 10 per cent return on its investment when the European Union blocked the deal due to antitrust concerns.

    Source: Source: “Atticus Global finds its strategy paying off” Clow, Robert, Financial Times, August 30th, 2001, p. 25.

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    danielbeunza

    April 20, 2010 at 4:15 pm

  8. Daniel: You’re right, these discussions can get ideological and suffer from problems of incommensurability of/between methods/approaches.

    That said, does performativity help us “better understand” economic phenomena? — that’s an interesting question. It overlays some language onto a given history, but I’m not sure that it meaningfully gets at underlying mechanisms nor allows us to make predictions. Yes, tools are used by actors in markets — I agree, and these tools matter in various ways. But, to then jump to an reality-independent set-up is way too big of a stretch for me (particularly since we know that tool-created realities actually get checked by reality) and it does not give credit to the actors and their efforts (note: under uncertainty).

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    tf

    April 20, 2010 at 7:00 pm

  9. I think performativity is useful not as a last-word meta-narrative but rather precisely because it does help us describe “better” what happens when some models are used. I conceptualize the performative process as an interplay between a model, a reality that fights back, and the model in turn fighting back against that reality and sometimes measurably changing it. That is the sense in which we can say such-and-such a model creates (not just describes) a reality.

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    Justin Kraus

    April 21, 2010 at 12:16 am

  10. Teppo — There is an inconsistency in your argument. You argue for “reality” on the grounds that it provides a healthy check. But then you avoid confronting the realities that I describe in my paper, preferring instead to stay within general statements about performativity.

    If you truly believed that realities limit social construction, would you not apply this principle to your own beliefs and expose them to the facts?

    The facts that I describe on my paper are that arbitrageurs lost their shirts in the GE-Honeywell trade, even as disconfirmatory evidence built up right in front of their eyes. The other fact is that they keep referring to “implied probability”, a magnitude that has no meaning outside the world of models. Why don’t we debate these?

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    danielbeunza

    April 21, 2010 at 4:28 pm

  11. “If you truly believed that realities limit social construction, would you not apply this principle to your own beliefs and expose them to the facts?”

    Excellent point. So, does the earth orbit the sun? Yes, independent of our perceptions and models of it (which have been corrected over time). Social interaction, of course, adds very interesting dynamics into the model-reality relationship, but, clearly there are very real boundaries.

    “The facts that I describe on my paper are that arbitrageurs lost their shirts in the GE-Honeywell trade, even as disconfirmatory evidence built up right in front of their eyes. The other fact is that they keep referring to “implied probability”, a magnitude that has no meaning outside the world of models. Why don’t we debate these?”

    So, the arbitrageurs were wrong and disillusioned — I have no qualms with wrong models creating worlds of their own. Though, note that saying that a model is “wrong” is explicitly outside the performative system (which does not allow value judgments — good, bad, better, wrong — arguing rather that models are, per Callon, arbitrary). And, the arbitrageurs eventually lost their shirts.

    You’re absolutely right, I need to read the paper closely to get into the arguments and nuance more specifically.

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    tf

    April 21, 2010 at 5:20 pm

  12. […] How economic sociology is different from behavioral finance – via OrgTheory – Daniel Beunza addresses the difference between economic sociology and behavioral finance in a new blog post. Daniel provides an answer to the question of what makes them different, drawing of course on his own work in the social studies of finance. Both fields are interested in how market outcomes deviate from those you’d expect given the lens of the efficient market hypothesis, but Daniel asserts that behavioral finance looks to individual biases as a source of inefficiency while economic sociology focuses on the social conditions (e.g., technology) that cause deviations in pricing. […]

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