Beyond Mechanical Markets: Asset Price Swings, Risk, and the Role of the State [Hardcover]

The premise that government should intervene in markets in a soft way at the margins just to mitigate the worst run ups (or downs) of asset swings is not novel. The book does not answer the question that has always been asked of any economist seeking to manage markets: how would it be implemented? As with any management of markets for results more beneficial to society, it sounds great. The devil is the details though, and we never get those. I have to agree with the reviewer who said that it is not particularly clearly written and does not seem to know what audience it is adressed to.

I found it strange that the author focused on possible means for governments to mitigate asset swings, but not once mentioned the many government interventions that exascerbate them (Freddie and Fannie, mortgage interest deduction, public campaigns to promote an "ownership society", relaxing regs as the price swing gained strength, etc. in the housing crisis, for example). It was as if asset price swings happen comepletely independently of government policy, except the non-specific government policies he is recommending that will not have any unintended consequences like other government interventions.

The authors start by going back to Knight and Hayek to make the point that there is genuine uncertainty about the future. Traditional finance models do not take this into account. I fully agree with the gist of this argument. However, it is not at all a novel argument and this chapter reads like a disjointed dissertation chapter. The novel part comes in the second half of the book. Here the book starts to become very blurry. I think for two main reasons:
(1) The authors have not thought about the target audience of the book. Is it regulators (maybe), academics (probably not), traders (probably not but they might pick up the book), economists (probably)? My guess in parenthesis. The key problem is that the authors do not seem to have made up their mind.
(2) The authors never state arguments up-front. Instead they proceed in a meandering manner assuming that the reader is able to tease out their key arguments. This is totally unacceptable.

Some books are difficult to understand but you get a feeling that the author has done everything to make the content accessible. I don't mind struggling to get through such books. In this particular case, I don't get the feeling that the authors have something very unique or clear to state. I might be wrong, but one need to make decisions under uncertainty. I have given four chapters of the book an honest attempt.

UPDATE 2013: Just want to make sure I don't give out one star without it being fully deserved. I have given the book another chance and again I was struck by the poor quality of language. Sadly, the authors just do not command the English language.

I tend to disagree with most of the previous review, though he said he only read four chapters so...

The authors very clearly state their audience, they aim to make the underlying assumptions of economists' discourse (and thus policy prescriptions) more concretely illustrated to these very economists and the general populace (a daunting task in either instance, let alone both).

I do agree that if they laid out some of their concluding points earlier it would have helped to digest some details building to it for those not familiar with the professional literature (or better the authors' previous work). I think though the goal was for readers to learn through a process of digestive thinking, rather than direct steering to an overall advocacy/understanding/approach (rather they acknowledge some can accept a degree of their points over a spectrum that may fall short of 100%).

It is a very important issue of course (if the way we think about the world is flawed, certainly it will make any attempts to improve the world much more suspect), and one that would take much convincing to uproot the profession of its pretensions (of exact knowledge, barring random shocks, as opposed to the presence of changes in parameters and relationships with expectations, which could be based on an ever changing set of factors).

The final chapters in particular are incredibly substantive, and point to new understandings of risk behavior on a very practical level. According to their model based on more plausible assumptions, as well as their empirical work testing against reality, risk is based not on volatility but the length of upswings and downswings in assets (relative to earnings with stock prices and purchasing power in exchange rates for example). This is a very intuitive understanding, astoundingly still generally absent from much of the academic literature and risk management by private institutions and regulators. Also with instability of economic relationships in terms of exact estimates, though qualitatively useful (quantitative instability likely due to changes not only forecasts, but forecasting strategies, and thus coefficients).

I think some of the beginning epistemological arguments may strike some as too abstract or conversely repetitive and obvious (again a problem of a wide audience), but I think it deserves its own treatment in a book on the philosophy of the science of economics (which they have done). I do think that given the fact they have more to offer from their own research, they might have done readers a favor emphasizing and re-emphasizing their improvements in understanding discussed at the end from the very beginning and repeatedly (though extensively discussed in their earlier book). For example that risk is not based on how much prices go up or down day to day (volatility), but how far they have risen in the recent past (relative to those benchmarks), that upswings in prices don't come from falls in risk preferences (and in fact the exact opposite based on evidence, swings raise risk assessment) but rather are driven by expectations of higher returns. These seem quite obvious in retrospect, though again terribly under recognized. Also that relationships based on (likely any finite) given information sets will break down over time.

Still this is a book which both pragmatists and intellectuals would benefit from reading by leaps and bounds (as evidenced by the ringing endorsements from leading thinkers in both arenas).