Behavioral finance FAQ / Glossary (Over-reliance)

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Dates of related message(s) in the
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Year/month, d: developed / discussed,
i: incidental

Over-reliance on analysts, experts, advisors

See my ex knol.on this topic
+ see obedience, guru, goal

 

Over-reliance on management objectives and norms

See goal, behavioral corporate
management, numeracy bias,

Businesses and other institutions rely largely on "MBO-management by

objectives" and "MIS-management information systems".

  They can be defined as systems in which:

* personal (or team) objectives and norms are decided
* results are compared with those stated goals


Pros and cons

MBO has become a standard of management as it is highly useful to boost
performance
and also to prepare, support and follow actions plans.


On the other hand those normative tools can have perverse effects,

By resting on too reductive goals, and on straightjacket norms and
    practices
(sometimes obsolete) that reduce the latitudes for initiatives,

innovation and adaptation

By generalizing staff control (carrot and stick) and bringing
    stress that can stifle the staff morale

By inciting to cheat on the results (cooking the stats).

By privileging short term and quantitative results instead of long term
   and qualitative ones

 

Over-reliance on numbers, models

See numeracy bias,
model

Over-reliance on rules, regulation



See behavioral public
economics, unintended
consequences, moral
hazard

A sinister precedent

The temptation, after a crisis like the subprime crisis, is to create new and
stricter regulations.
A paradox as one of the causes of the crisis was ...a regulation.

The "capital adequacy ratio" for banks gave them the incentive
to transfer
loans, and above all dubious loans, from inside to
outside their balance sheet.

A conjurer trick, the card that was in the right hand is now under the left
sleeve.

They were repackaged, we could say disguised , as "structured
financial securities (what is called securitization), sweetened with some
derivatives, and sold ...to other banks usually.

This opened the door to subprime loans, miraculously transformed, through
a deceptive mixing process that turned hashed rotten chicken into pheasant
pâté, into apparently safe investment that allowed to meet artificially the

solvency criteria so as not to deteriorate the banks' balance sheets.

A mountain of them was created, until people understood that their

value was dubious and they became illiquid.

Then the crisis broke out!


How to avoid such crises in the future?

- By regulating those financial instruments?

- By raising the capital adequacy rules?

Btw, it is what has been done ("Basel III")...
...to give more incentive to circumvent them?

Who can really think that regulating the cause of a
past anomaly
will avoid the next one, that can be fully
different?

When one reason of the crisis was the loophole
created by a regulation?

A moral hazard (see that phrase) all financial authorities
were blind to (or supporting it)?

The fact is that regulations come most of the time too late, once the
harm done is discovered.

Or, when regulations try to anticipate it, the anticipation might be wrong. 

  What to do?

The solution can only be to prevent such blindness more than regulating
the past.
It means to have:

General transparency, safety and ethical principles.
   
The more general, the better!

Smarter independent watchdogs who anticipate what new
   
forms the nest biases would take, what new excesses (in prices,
    returns, volumes,
financial leverage...) are building up.

OK, but what kind of watchdogs? Let us look closer:

Those supervisors should not be just bureaucrats
   who:

  • are happy to see that the rules are apparently not broken

  • or understand and lament the biased game, but lack power
    to strike.

They should be recruited among high level professionals, with 

experience of the game, able to see what is going on in the
restaurant kitchen and to anticipate and understand what other
professionals are inventing to distort the system.

They should be very well paid, because of their competence,
    and
also to stay "incorruptible".


They should have full access and full authority on all
   financial areas, as real Caesars.

Their scope should be global, as finance is a
    global activity
.

Why not a World Financial Authority, and/or a World Financial
Court?


Even more crucial, they should take a monk-like commitment
   never
to be influenced by the general mood and the belief

that markets always know better even when they enter extreme
behaviors, contrarily to what
the "efficient market hypothesis"
(see that phrase)
instilled in 
many weak (and greedy) minds.

In fact they would be "behavior observers", not only number
crunchers.

 

A related bias
     Overreliance on management objectives and norms

(see the specific glossary article)

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This page last update: 11/09/15  

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