Finance Is A Social Science, Not A Branch Of Mathematics

The markets seems to forget this. People act as if finance is just mathematics.

Finance is a branch of economics, a social science, and not a branch of mathematics.
Yes, mathematics is used in finance, as a tool. But that does not make finance a natural science.
Finance, part of economics belongs in the social sciences department of your university, not in the natural sciences department.

If you look at banks, funds, statistical authorities, central banks and governments there is way way way to much emphasis on finance as a mathematical science. People actually even believe it is a mathematical science and ridicule those who  think otherwise.

We believe the reason for this is that finance as math, or the quantitative approach, is something people can agree on, and agree to disagree. There are mathematical models and terms to encapsulate disagreement.

People try to avoid disagreement and confrontation. The more politics there is in a financial institution the more they avoid disagreement and confrontation. Thus you will find that most large financial institutions focus on quantitative finance.

And, because the dynamics of politics is the same in all large organizations. They all pretty much operate the same way they tend to act the same way. The use the same kind of mathematical models. The politically correct models will over time crowd out the politically unacceptable . They buy the same kind of assets for the same kind of reasons and sell the same kind of assets for the same kind of reasons.
They are regulated by the same legal framework and adapt to the same legal framework.

Small groups can have a coherent qualitative view, but this is extremely hard. That is why all the best advice in economics comes from individuals with a strong qualitative approach. Finance by committee is as bad as management by committee.

Finance as a social science is much more demanding. Here you have to actually have a mental model of how the world works, and of human action. This will by necessity lead to influence you in all aspects of life. And if you put two good and honest qualitative economist in a room they will pretty soon find points where they disagree.

Finance as a social science is extremely demanding of the practitioner. One has to be a whole person, a well rounded person, a reflective mind. The person I am most fearful of in finance is the math genius, that  one that has been hired right out of the mathematics department as a “risk assessment analyst”, he might grasp the math but has not idea of the human action driving the market.

The current turmoil in the markets has shown that these people did not expect this. It is a 3 standard deviations event, a once in a decade event etc is their language for saying that what they are doing is way off.

But do not expect this to change anytime soon. As soon as the markets calm down, the dust settles, and there is a new direction everything will be back to where it was.

It is during times of tremendous stress and turmoil that this facts of life  become apparent and need to be pointed out.

We are of the Austrian school of economics where we believe you can gain more insight into the economy while clearing your mind during a long walk, or in the bathtub, than you can sweating it over a calculator in an office.
But this is a politically unacceptable approach, and that is why we do not work in a large organization.

Sept 23. 2008 Gran Canaria, Spain. Hans Lysglimt

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