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Since undergrad while taking economics classes, I thought this was entirely obvious. And honestly, I still do. To assume everyone is a rational actor is to as

by nscalf 9y ago

Since undergrad while taking economics classes, I thought this was entirely obvious. And honestly, I still do. To assume everyone is a rational actor is to assume everyone is perfect: they don't make mistakes, they don't have asymmetric information, etc. You can already see the changes that this articles suggests should happen in practice with high speed trading. I'd love a more detailed article, because this describes something obvious and vague.

bllguo 9y ago
You may be misinterpreting things. Relevant from Wikipedia: "Lo argues that much of what behaviorists cite as counterexamples to economic rationality—loss aversion, overconfidence, overreaction, and other behavioral biases—are, in fact, consistent with an evolutionary model of individuals adapting to a changing environment using simple heuristics." And as an aside, I am pretty tired of people saying things like this, without fail, in every thread about economics. A simplified model is better than no model at all. People have been trying to account for irrationality for ages. It's not particularly astute to recognize that individuals are not perfectly rational.
- cat199 9y ago
  nor is it particularly astute to create an entire discipline used to justify our entire social order on a theory that is known at the onset to be incorrect, all the while claiming it is more 'rational' and less 'superstitious' than the ones that came before it..
  - dsacco 9y ago
    Which theory specifically is used to "justify our entire social order"? How do we know it's incorrect, and what are the criteria for a successful theory?
    - alexandercrohde 9y ago
      Well, I don't intend to defend the blanket phrasing of GP, let's take for example GDP and it being taken seriously as a measure of a country's progress. I would wager just about any undergrad could come up with a superior measure to GDP.
      - deleted 9y ago
        [deleted]
      - cat199 9y ago
        the bold new idea of GDP/capita, perhaps.. hmm.
    - cat199 9y ago
      rational free market theory; humanistic positivism, etc. in the case of rational free market theory, even OP pointed out the logical problems inherent in this theory, i shan't repeat here since it doesn't deviate from the thread
  - geezerjay 9y ago
    > nor is it particularly astute to create an entire discipline used to justify our entire social order on a theory that is known at the onset to be incorrect, This is precisely what makes your line of argument tiresome: you fail to understand the very basics of what models are and how they are used. What determines if a model is valid or not is its error margin for the intended use. Even if a model fails to draw accurate predictions, its ability to express cause-effect consequences is enough to demonstrate the model's usefulness. It makes absolutely no sense at all, and flies in the face of reason, to criticize a model because it might not be very accurate at representing a corner case. That's a very ignorant thing to claim. To paraphrase George Box: "All models are wrong but some are useful". It seems you failed to understand the latter.
    - cat199 9y ago
      > This is precisely what makes your line of argument tiresome: you fail to understand the very basics of what models are and how they are used. no, this is precisely what makes your line of argument argument tiresome - choosing one inherently biased and flawed model over another because you prefer the way that the biases look.. and actually I wasn't "arguing" for/against anything - but pointing out logical inconsistencies in an already occurring exchange..
- nerdponx 9y ago
  The problem is not that people are irrational, the problem is that the "rationality" is a convenient mathematical ideation, not a normative statement on how people ought to behave. It's just a terrible term.
  - quadrangle 9y ago
    "Rational" is definitely used badly. It's originally about ratio which means simply that we can compare things with mathematical accuracy, the assumption being that we use such processes in all sorts of thinking, but that's absurd. That it has come to mean something like "reasonable" is unfortunate.
  - nerfhammer 9y ago
    If people didn't act by some reasonable definition of rational to a large degree then how could economies work? What do you value? What tradeoffs would you be willing to make for it? Now, let's assign those ratios numeric values...
    - nerdponx 9y ago
      Good luck eliciting those numerical assignments, and then tracking them as they change in continuous time based on what your rational agent ate for lunch, how his sex life has been recently, et al.
- crdoconnor 9y ago
  "I am pretty tired of people saying things like this, without fail, in every thread about economics. A simplified model is better than no model at all." Funny. I'm pretty tired of people saying that a terrible model that makes terrible predictions is better than no model. The unifying feature of perfectly rational, perfect information and a perfectly competitive market is not that they are the best way to simplify economic models, it's that they're the best ways of creating models that conceal true sources of profit.
- lucozade 9y ago
  A simple model is better than no model when it makes useful predictions over a well defined domain. The main problem with most models of market economics is that they only work when nothing interesting is happening. Probably the best, as in most practically useful, idea from market economics has been that of arbitrage freedom. And even that falls apart in low liquidity scenarios which often characterise severe events.
- Firadeoclus 9y ago
  > A simplified model is better than no model at all. This is true in physics where the system being modelled is governed by stable laws. You can confirm the model's predictive usefulness by experiment. If you test the model and find its limitations, you expect them to hold in 50 years' time. Economic models, however, are themselves part of the economy. The ideas they are built on and their predictions become part of wider knowledge and influence the very thing the model is trying to predict or explain, possibly reinforcing or weakening certain behaviours. If a simplified model becomes widespread it can lead to blind spots in our understanding which cause systemic issues. Of course that doesn't mean the model was bad or unsuitable for its original intent. But a simplified model can, in the wrong hands, be a net negative.
  - vertere 9y ago
    > Economic models, however, are themselves part of the economy. The ideas they are built on and their predictions become part of wider knowledge and influence the very thing the model is trying to predict or explain, possibly reinforcing or weakening certain behaviours. Which is the very problem "rational expectations" modeling [0] is trying to avoid. Rational expectations models don't 'know' anything (systematic) that the actors in it don't. [0] https://en.wikipedia.org/wiki/Rational_expectations https://en.wikipedia.org/wiki/Rational_expectations
  - bllguo 9y ago
    That is an interesting point, that people have bought too much into this simplified model s.t. reality bends towards the model. I don't know if I blame the model for that - like you say in your last sentence. But what's the alternative besides starting with simplifications and iterating?
r00fus 9y ago
rational actor in econ ≈ uniform spherical cow in physics
- uoaei 9y ago
  Absolutely not. I keep seeing this simplification thrown around and it's patently false. The uniform spherical cow analogy works better when saying "consider a nation-state as a single actor in a global economy." The rational actor assumption is more along the lines of the continuum approximation in fluid dynamics: that even though we don't have the power to model each individual molecule, we can do well enough by applying heuristics on top of that (pressure, density, etc.) that we can reason out some cause-effect behavior by measuring and tracking those higher-level quantities. We can even derive equations from them, though they may not have analytical solutions. The problem with this is of course not just the inhomogeneity of the environment with respect to these higher-order quantities, but with the molecules themselves. This combined with strong nonlocal effects makes economics a really really difficult science to pin down mathematically, so all we seem to be able to do so far is fit the data to one of a few common models and wipe our hands clean of it.
dsacco 9y ago
I'm not really following you. Rationality and adaptive markets hypothesis are not mutually exclusive. Moreover you seem to be attacking a strawman of what economists mean when they use the term, "rational actor". Economists do not actually assume everything is perfect or that the market is perfectly efficient - not even Fama postulates that. Rational behavior is an approximation, and economists are such approximations do not perfectly model the market. That doesn't mean they don't have any predictive ability or empiricism. I also didn't see any changes suggested by the article - there doesn't seem to be anything in it that's at all prescriptive; how are you drawing a connection to HFT?
- wahern 9y ago
  The rational actor model implies things like transitivity of preferences. The rational actor model, even an "approximate" model which accounts for errors and limited information, is fundamentally broken because we know that humans _systematically_ violate such basic premises as transitivity. Put another way, we could just as easily say that non-human animals approximate rational actors because populations rather quickly approach efficient ecological equilibriums. But that sort of framing is not very helpful.
aaron695 9y ago
> To assume everyone is a rational actor No one assumes or thinks this. Economists know about mental illness for starters. They assume there exists enough rational actors within the market such that it's run by rational actors. What you'd need to think is.. no one in the market is a rational actor or a lessor form there are not enough ration actors in a market to keep it running, to think differently.

by nscalf 9y ago

bllguo 9y ago

You may be misinterpreting things. Relevant from Wikipedia: "Lo argues that much of what behaviorists cite as counterexamples to economic rationality—loss aversion, overconfidence, overreaction, and other behavioral biases—are, in fact, consistent with an evolutionary model of individuals adapting to a changing environment using simple heuristics." And as an aside, I am pretty tired of people saying things like this, without fail, in every thread about economics. A simplified model is better than no model at all. People have been trying to account for irrationality for ages. It's not particularly astute to recognize that individuals are not perfectly rational.

cat199 9y ago
nor is it particularly astute to create an entire discipline used to justify our entire social order on a theory that is known at the onset to be incorrect, all the while claiming it is more 'rational' and less 'superstitious' than the ones that came before it..
- dsacco 9y ago
  Which theory specifically is used to "justify our entire social order"? How do we know it's incorrect, and what are the criteria for a successful theory?
  - alexandercrohde 9y ago
    Well, I don't intend to defend the blanket phrasing of GP, let's take for example GDP and it being taken seriously as a measure of a country's progress. I would wager just about any undergrad could come up with a superior measure to GDP.
    - deleted 9y ago
      [deleted]
    - cat199 9y ago
      the bold new idea of GDP/capita, perhaps.. hmm.
  - cat199 9y ago
    rational free market theory; humanistic positivism, etc. in the case of rational free market theory, even OP pointed out the logical problems inherent in this theory, i shan't repeat here since it doesn't deviate from the thread
- geezerjay 9y ago
  > nor is it particularly astute to create an entire discipline used to justify our entire social order on a theory that is known at the onset to be incorrect, This is precisely what makes your line of argument tiresome: you fail to understand the very basics of what models are and how they are used. What determines if a model is valid or not is its error margin for the intended use. Even if a model fails to draw accurate predictions, its ability to express cause-effect consequences is enough to demonstrate the model's usefulness. It makes absolutely no sense at all, and flies in the face of reason, to criticize a model because it might not be very accurate at representing a corner case. That's a very ignorant thing to claim. To paraphrase George Box: "All models are wrong but some are useful". It seems you failed to understand the latter.
  - cat199 9y ago
    > This is precisely what makes your line of argument tiresome: you fail to understand the very basics of what models are and how they are used. no, this is precisely what makes your line of argument argument tiresome - choosing one inherently biased and flawed model over another because you prefer the way that the biases look.. and actually I wasn't "arguing" for/against anything - but pointing out logical inconsistencies in an already occurring exchange..
nerdponx 9y ago
The problem is not that people are irrational, the problem is that the "rationality" is a convenient mathematical ideation, not a normative statement on how people ought to behave. It's just a terrible term.
- quadrangle 9y ago
  "Rational" is definitely used badly. It's originally about ratio which means simply that we can compare things with mathematical accuracy, the assumption being that we use such processes in all sorts of thinking, but that's absurd. That it has come to mean something like "reasonable" is unfortunate.
- nerfhammer 9y ago
  If people didn't act by some reasonable definition of rational to a large degree then how could economies work? What do you value? What tradeoffs would you be willing to make for it? Now, let's assign those ratios numeric values...
  - nerdponx 9y ago
    Good luck eliciting those numerical assignments, and then tracking them as they change in continuous time based on what your rational agent ate for lunch, how his sex life has been recently, et al.
crdoconnor 9y ago
"I am pretty tired of people saying things like this, without fail, in every thread about economics. A simplified model is better than no model at all." Funny. I'm pretty tired of people saying that a terrible model that makes terrible predictions is better than no model. The unifying feature of perfectly rational, perfect information and a perfectly competitive market is not that they are the best way to simplify economic models, it's that they're the best ways of creating models that conceal true sources of profit.
lucozade 9y ago
A simple model is better than no model when it makes useful predictions over a well defined domain. The main problem with most models of market economics is that they only work when nothing interesting is happening. Probably the best, as in most practically useful, idea from market economics has been that of arbitrage freedom. And even that falls apart in low liquidity scenarios which often characterise severe events.
Firadeoclus 9y ago
> A simplified model is better than no model at all. This is true in physics where the system being modelled is governed by stable laws. You can confirm the model's predictive usefulness by experiment. If you test the model and find its limitations, you expect them to hold in 50 years' time. Economic models, however, are themselves part of the economy. The ideas they are built on and their predictions become part of wider knowledge and influence the very thing the model is trying to predict or explain, possibly reinforcing or weakening certain behaviours. If a simplified model becomes widespread it can lead to blind spots in our understanding which cause systemic issues. Of course that doesn't mean the model was bad or unsuitable for its original intent. But a simplified model can, in the wrong hands, be a net negative.
- vertere 9y ago
  > Economic models, however, are themselves part of the economy. The ideas they are built on and their predictions become part of wider knowledge and influence the very thing the model is trying to predict or explain, possibly reinforcing or weakening certain behaviours. Which is the very problem "rational expectations" modeling [0] is trying to avoid. Rational expectations models don't 'know' anything (systematic) that the actors in it don't. [0] https://en.wikipedia.org/wiki/Rational_expectations https://en.wikipedia.org/wiki/Rational_expectations
- bllguo 9y ago
  That is an interesting point, that people have bought too much into this simplified model s.t. reality bends towards the model. I don't know if I blame the model for that - like you say in your last sentence. But what's the alternative besides starting with simplifications and iterating?

r00fus 9y ago

rational actor in econ ≈ uniform spherical cow in physics

uoaei 9y ago
Absolutely not. I keep seeing this simplification thrown around and it's patently false. The uniform spherical cow analogy works better when saying "consider a nation-state as a single actor in a global economy." The rational actor assumption is more along the lines of the continuum approximation in fluid dynamics: that even though we don't have the power to model each individual molecule, we can do well enough by applying heuristics on top of that (pressure, density, etc.) that we can reason out some cause-effect behavior by measuring and tracking those higher-level quantities. We can even derive equations from them, though they may not have analytical solutions. The problem with this is of course not just the inhomogeneity of the environment with respect to these higher-order quantities, but with the molecules themselves. This combined with strong nonlocal effects makes economics a really really difficult science to pin down mathematically, so all we seem to be able to do so far is fit the data to one of a few common models and wipe our hands clean of it.

dsacco 9y ago

I'm not really following you. Rationality and adaptive markets hypothesis are not mutually exclusive. Moreover you seem to be attacking a strawman of what economists mean when they use the term, "rational actor". Economists do not actually assume everything is perfect or that the market is perfectly efficient - not even Fama postulates that. Rational behavior is an approximation, and economists are such approximations do not perfectly model the market. That doesn't mean they don't have any predictive ability or empiricism. I also didn't see any changes suggested by the article - there doesn't seem to be anything in it that's at all prescriptive; how are you drawing a connection to HFT?

wahern 9y ago
The rational actor model implies things like transitivity of preferences. The rational actor model, even an "approximate" model which accounts for errors and limited information, is fundamentally broken because we know that humans _systematically_ violate such basic premises as transitivity. Put another way, we could just as easily say that non-human animals approximate rational actors because populations rather quickly approach efficient ecological equilibriums. But that sort of framing is not very helpful.

aaron695 9y ago

> To assume everyone is a rational actor No one assumes or thinks this. Economists know about mental illness for starters. They assume there exists enough rational actors within the market such that it's run by rational actors. What you'd need to think is.. no one in the market is a rational actor or a lessor form there are not enough ration actors in a market to keep it running, to think differently.