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pp. 1-3

Notes in the Margin—The 2002

Nobel Prize in Economics





Not to lag behind the hard sciences, the Nobel Committee for Economics, in October 2002,announced the names of this year’s laureates, Vernon Smith and Daniel Kahneman. First, I wish to express my warmest congratulations to the recipients, and assure them that the prize is well deserved. In fact, at the 1998 Aspen conference of the Institute of Psychology and Financial Markets, an organization that numbers Smith and David Dreman among its founders, I told Vern that when the Nobel Committee eventually recognized the contribution of experimental economics to the field he would be a recipient of the prize. He dismissed my remark as something typical of an economist’s forecast—always, unfortunately, wrong.

The other recipient, Daniel Kahneman of Princeton, is not an economist at all, but a psychologist. Kahneman, with the late Amos Tversky, invented prospect theory [1974, 1979]. PT was to become the theoretical foundation of what are today called the overreaction and under reaction hypotheses and the contrarian literature, giving academic legitimacy to behavioral finance. Contrarian theory has been shown to be quite successful, especially after the market meltdown of 2002, in the investment policies and performance of Dreman Asset Management. That behavioral economics is the wave of the future, according to the judgment of the Nobel Committee, one could have gleaned from its decision the year before. In 2000 the prize
went to three economists. Two of them are considered the founding fathers of behavioral economics: George Akerlof [1970] and Michael Spence [1974]. The signal of the committee the year before did not escape the attention of the mainstream media. In a February 11, 2001, column, titled “Following the Money, but Also the Mind,” Louis Uchitelle, the chief economics correspondent of The New York Times, predicted a rosy future for behavioral economics.

Uchitelle mentions in his article a dozen or so economists, among them a few who are financial, but all exclusively from “elite” universities. Smith’s name did not register with Uchitelle, for how can one make a contribution to a new way of thinking in economics (for over two decades) when one is after all, from the University of Arizona, or George Mason University? Nevertheless, the chief economics maven of the Times had this to say:


By 1985, Mr. Akerlof had met the two psychologists whose research and experiments, in collaboration with various economists, produced many early findings of behavioral economics. One of them, Amos Tversky, died in 1996; the other, Daniel Kahneman, now at Princeton, taught a graduate seminar on psychology and economics with Mr. Akerlof at Berkeley.
     “George did not get credit for that course,” Dr. Kahneman recalled. “The idea of teaching with a psychologist was considered so flaky that he was told to do it on his own” [2001, Section 3, p. 1].


If the signal in 2000 were lost on anyone, this year it could have been stronger only if it had been awarded posthumously to Sigmund Freud or Carl Gustav Jung. De facto, the committee said, to paraphrase our former president, “it’s the behavior, stupid.”


It also said that neoclassical economics, financial or otherwise, is not the wave of the future, because we cannot explain the complexities of 21st century life without understanding human behavior as individuals and as a group, considering culture, politics, and ethnicity. The decision is also a certification that the movement that got its start in France in the summer of 2000, spreading all over the world, and calling itself post-autistic economics (a synonym for post-modernity in economics), or PEA for short, is not just legitimate, but also the way to go.


Should we be happy, and break out the beer and the potato chips? Not so fast! Financial economics, or modern finance, is still ruled by the high priests of neoclassical orthodoxy. Also, in the theological seminaries of the religion of market efficiency (RME) (read departments of finance all over the land), the young cadres of theologians are taught that no world exists not described by the CAPM, the OPM, APT, or the free cash flow hypothesis. It is strictly Friedmanian [1953] positivism, reinterpreted by Sharpe [1964] and Fama [1965, 1970, and 1998].


According to the RME, models that do not imitate physics have no place in finance. Those who man the bastions of the faith do not like to hear how Uchitelle sees the future

Behavioral economists help to explain how booms persist while busts, like the one that the United States may now be entering, are difficult to reverse. Their research sheds light on why identity—the traits people assign to themselves and to others—plays a huge and often damaging role in the economy. If the behaviorists are correct, shares of companies on the New York Stock Exchange are overvalued and the Dow Jones industrial average has further to fall. And if the behaviorists prevail, the mainstream view of a rational, self-regulating economy may well be amended and policies adopted to control irrational, sometimes destructive behavior. Twenty-five years of deregulation might lose its appeal [2001, Section 3, p. 1].

Positivists especially dislike that last sentence. What they do like is models of mathematics, and the fanciest statistical footwork econometrics can invent. Thus, they are  ARCHing, GARCHing, and EGARCHing all the data they can lay their hands on, and that is how they train the young cadres in the field. Anything else is not only discouraged but also strictly verboten.


A letter I received from a former student after my retirement includes this paragraph (not quoted in its entirety):

Earlier this year in my Theory of Finance course someone questioned why utility theory, because it is based on assumptions which we know to be false, is worthy of study. Professor Tunnelvision [I changed the name to protect the guilty] implied that because of Friedman’s admonition that assumptions are not important, and that all that matters is how a theory measures up to empirical evidence, we don’t have to bother with such “philosophical” questions. I responded that Friedman’s assertion was in itself the statement of a philosophical position. Another student commented that “this is a finance course and not a philosophy course.” My response was that if we consider ourselves “scientists” we could not shrink from such philosophical questions. Dr. Tunnelvision responded that Friedman’s position was THE philosophy of modern finance, and that if I hoped to get published it would be my philosophy as well. Everyone in the class laughed at this statement but me. I left the class wondering what self-respecting scientist would make a statement such as that.

There are several key philosophical issues wrapped in this paragraph, leaving one wondering about the delicate undersides of educating our new cadre of researchers. It would be impossible to squeeze them all into the confines of this comment, but one issue is very bothersome to me, and should concern everyone else who believes that the major role of science, and the ultimate responsibility of scientists, is discovery.


This is the distressing fact that Professor Tunnelvision gave the student the practical advice that if the young Ph.D.s, fresh out of school, want to keep their jobs, and eventually be promoted and tenured, they must fall in line. This makes progress next to impossible, and one must find the way to break out of this vicious cycle.


As I have argued elsewhere, behavioral finance must grow from cooperation with other social scientists. This is a difficult road to travel, because such cooperation is practically non-existent. Candidates for the Ph.D. in finance, if not totally prohibited, then are actively discouraged from acquiring an education in these sciences, and they are surely foreclosed from writing a dissertation in combination with these scholars.


So, if we want to shed the straight jacket of modern finance, and many—the Nobel Committee for sure—think we should, we must do something about it beyond talk. This is so because talk is not merely cheap; it is unfortunately as inefficient as our markets are. The Nobel Prize is both money and (perhaps foremost) prestige, but the chances of one of us in economics, financial or otherwise, getting it, are less than any one of us in economics, financial or otherwise, being drafted by the NBA.


We need “campaign finance reform” in academia that would provide generous funding for work done in cooperation with other disciplines of the social sciences—because, sadly, what talks is money, not just in politics, but in academe as well. This would provide the right incentive for faculty and Ph.D.s to do research that would not be forthcoming otherwise.


We also need outlets for work that today has no chance at all to be published in the leading journals of the field. This is desperately needed because of the structure of the promotion and tenure process. If one is not published in the leading journals of the field, one does not get promoted or tenured. If one does research that is not in line with the religion of market efficiency, one does not have a chance to publish in these journals, regardless of the quality of one’s work. This Catch-22 must be broken if we want to make progress.


Fortunately, there are a few journals that would consider favorably good-quality work that is not “traditional”: The Journal of Psychology and Financial Markets, IRFA, JEBO, Homo Oeconomicus, and a few others on the purely academic side, and this Journal on the side that also tries to communicate with the practitioners of finance. I have personally benefited from the willingness of these journals to publish my work that has been iconoclastic. If more people, perhaps far better than I, would send their work to these journals, perhaps they would be considered after a while the leaders of the field.*


This is not a quick and easy road, but unfortunately there is no other one to travel. And perhaps we will find the intellectual resources among our fellow academics that would go beyond the mental capacity needed for yet another event study.


Ergo, as both an optimist and a survivor, I rejoice in the decision of the Nobel Prize Committee, as I hope for a scientific revolution to come and to still to be around to witness it.




* Ironically, modern finance/financial economics has replaced what in the early 1960s was called traditional or institutional finance. As modern finance succeeded in colonizing financial academia, it is now called traditional finance. This is to show how words serve as place holders, as their real meaning changes. In the semiotic theory of de Saussure [1959], the former is la parole, and the latter is la langue.





Akerlof, George. “The Market for ‘Lemons’: Quality Uncertainty and the Market Mechanism.” The Quarterly Journal of Economics, 84 (1970), pp. 488-500.


Fama, Eugene F. “The Behavior of Stock Market Prices.Journal of Business, 38 (1965), pp. 34-105.


——. “Efficient Capital Markets: A Review of Theory and Empirical Work.” Journal of Finance, 25 (1970), pp. 383-417.


——. “Market Efficiency, Long-Term Returns, and Behavioral Finance.” Journal of Financial Economics, 49 (1998), pp. 283-306.


Friedman, Milton M. “The Methodology of Positive Economics.” In M. M. Friedman, ed., Essays in Positive Economics. Chicago: University of Chicago Press, 1953.


de Saussure, Ferdinand. Courses in General Linguistics. New York: McGraw-Hill, 1959.


Sharpe, William F. “Capital Market Prices: A Theory of Market Equilibrium under Conditions of Risk.” Journal of Finance, 14 (1964), pp. 425-442.


Spence, Michael. “Job Market Signaling.” The Quarterly Journal of Economics, 87 (1973), pp. 355-374.


Tversky, Amos, and Daniel Kahneman. “Judgment Under Uncertainty: Heuristics and Biases.” Science, 185 (1974), pp. 1124-1131.


——. “Prospect Theory: An Analysis of Decisions under Risk.” Econometrica, 47 (1979), pp. 263-291.


Uchitelle, Louis. “Following the Money, but Also the Mind.” New York Times. February 11, 2001, section 3, page 1.

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SPRING 2003 , pages 1-3.


GEORGE M. FRANKFURTER is Lloyd F. Collette professor Emeritus at Louisiana State University. He is network professor at the Graduate School of Management, Sabanci University, Tuzla/Istanbul, Turkey.