An in-depth look at how to account for the human complexities at the heart of today's financial system
Our economy may have recovered from the Great Recession—but not our economics. In The End of Theory, Richard Bookstaber, one of the world's leading risk managers, discusses why the human condition and the radical uncertainty of our world renders the standard economic model—and the theory behind it—useless for dealing with financial crises. What model should replace it? None. At least not any version we've been using for the past two hundred years. Instead, Bookstaber argues for a new approach called agent-based economics, one that takes as a starting point the fact that we are humans, not the optimizing automatons that standard economics assumes we are.
Bookstaber's groundbreaking paradigm promises to do a far better job at preventing crises and managing those that break out. As he explains, our varied memories and imaginations color our economic behavior in unexpected hues. Agent-based modeling embraces these nuances by avoiding the mechanistic, unrealistic structure of our current economic approach. Bookstaber tackles issues such as radical uncertainty, when circumstances take place beyond our anticipation, and emergence, when innocent, everyday interactions combine to create sudden chaos. Starting with the realization that future crises cannot be predicted by the past, he proposes an approach that recognizes the human narrative while addressing market realities.
Sweeping aside the historic failure of twentieth-century economics, The End of Theory offers a novel and innovative perspective, along with a more realistic and human framework, to help prevent today's financial system from blowing up again.
Richard Bookstaber has overseen risk management at investment banks Morgan Stanley and Salomon Brothers, as well as major hedge funds such as Moore Capital and Bridgewater. He has also held positions at the U.S. Treasury, and is currently at the University of California. He is the author most recently of A Demon of Our Own Design (Wiley).
"The End of Theory does hold some important lessons for financial markets today. It also shows [Bookstaber] to be someone who adds a fair bit of humility into his models — which may be the best reason to read his book."--Rana Faroohar, Financial Times
"Erudite, fun to read, and sure to be a classic, The End of Theory discards the standard paradigms of economics. Financial crises, Bookstaber argues, are best modeled as they occur in reality: the heuristic interactions of humans in a complex environment."--Darrell Duffie, Stanford University
"Greg Mankiw said a decade ago, ‘The fact that modern macroeconomic research is not widely used in practical policymaking is prima facie evidence that it is of little use for this purpose.' In The End of Theory, Richard Bookstaber explains why this is so, and presents an alternative to change this situation. Showing that agent-based modeling provides a way of recognizing patterns that emerge as economic crises develop, Bookstaber's approach should help dampen crises and their impacts. What could be more important?"--Alan Kirman, director of studies, École des Hautes Études en Sciences Sociales and emeritus professor of economics, Aix-Marseille University
"Seeking to reorient economics research, this ambitious book outlines a strong alternative approach based on agent-based computational models. With a lively and engaging style, Bookstaber reveals a deep knowledge of several fields, including mathematics and computer science, and a practical understanding of the financial sector. His book is fun to read, pedagogically brilliant, and deeply erudite."--Rajiv Sethi, Barnard College
Table of Contents:
I: Introduction 1
1 Crises and Sunspots 3
2 Being Human 14
II: The Four Horsemen 23
3 Social Interactions and Computational Irreducibility 25
4 The Individual and the Human Wave: Emergent Phenomena 34
5 Context and Ergodicity 40
6 Human Experience and Radical Uncertainty 50
7 Heuristics: How to Act Like a Human 65
III: Paradigm Past And Future 79
8 Economics in Crisis 81
9 Agent-Based Models 94
10 Agents in the Complexity Spectrum 108
IV: Agent-Based Models For Financial Crises 125
11 The Structure of the Financial System: Agents and the Environment 127
12 Liquidity and Crashes 144
13 The 2008 Crisis with an Agent-Based View 157
V: The End Of Theory 169
14 Is It a Number or a Story? Model as Narrative 171
15 Conclusion 185