Behavioral finance FAQ / Glossary (Perverse)
This is a separate page of the P-Q section of the Glossary
Dates of related message(s) in the
Perverse effect, incentive
04/6i,7i + see incentive, unintended
consequence, moral hazard, public
choice, agent-principal, self defeating
Self-defeating good intentions,
or botched implementation?
A perverse effect of a decision or action, is
An unintended consequence (see that phrase) that
differs from, or is even the opposite of
what was expected
in a counterproductive or even
Here are main economic examples:
Some taxes, subsidies or regulations can be self-defeating,
Some management objectives or benchmarks (and related
bonuses offered to reach them), can neglect other goals.
For example, it can lead:
In corporate management, to ignore long term aims if those
incentives favor short term results that are easier to measure
In investing, to be happy to beat a stock market benchmark
by losing less than the index (relative instead of absolute
Some economic investment or project are counterproductive
(is it really smart to use badly needed cereals to make car fuel ?).
Some specific cases are also related to perverse incentives and moral
hazards (see the "incentive" and "moral hazard" glossary articles).
Are bank traders' bonuses
Should they play with my money and get the reward...
...while leaving me the risk?
There is a current issue about how justified are salary bonuses as performance
rewards given to bank staff active in short term trading for the bank's own
account ("proprietary trading") that involves high leverage operations and a
massive use of derivative financial instruments.
Pros and cons
The rationale is that trading gains are sizeable factor in banking
profits, thus they boost the bank means to make their traditional
The pitfall is that this speculative activity (see speculation) is much
riskier than traditional banking, as events have shown, notably the
subprime crisis bubble and crash).
Large bonuses for trading gains encourages the related staff to take
Whatever precautions are taken, it might endanger the bank and
therefore its customers' deposits.
Your money is on the roulette table, the gains are theirs, the
losses are yours!
How to limit that risk?
Two constraints could be considered:
The banks that are active in proprietary trading need
higher equity requirements.
A part of their gains (for example equivalent to the bonuses given to
traders) should feed a reserve account as a guarantee for deposits.
Or better, that portion should be credited to a global bank deposit
guarantee fund, linked for example to the International Monetary
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