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Financial Models and Society

Villains or Scapegoats?

Ekaterina Svetlova

This innovative book employs the social studies of finance approach which aims to enhance the dialogue between finance and sociology by addressing the blind spots of economic and financial theories. In so doing, it challenges the accusations made towards financial models in the aftermath of the last economic crisis and argues that they cannot be condemned indiscriminately. Their influence on markets and society is not straightforward, but determined by the many ways in which models are created and then used. Ekaterina Svetlova analyses the various patterns of the application of models in asset management, risk management and financial engineering to demonstrate that their power is far more fragile than widespread criticism would indicate.
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Index

Villains or Scapegoats?

Ekaterina Svetlova

action-like decision-making 3, 29, 32, 38, 39, 4951, 66, 69, 86, 107, 126, 145, 148
see also financial decision-making
active portfolio management, hybrid styles and quantamental investing 7074
advisory overlay 72
Alexandrova, A. 54
Amazon.com Inc. 96
Amoore, L. 155
“animal spirits” 26, 123, 147, 150
application-dominated research, finance as 5961
Arjaliès, D.-L. 6, 512, 72
asset management 71
asset managers 20, 98, 99
judgment and intuition 100
Austin, J. 130
Ayache, E. 22, 46
backing out modelling 74, 88
market expectations 9091
plausibility check of consensus 8992
reflexive modelling in merger arbitrage traders 923
reverse brokering 912
reverse DCF modelling 8990
backstage 40, 117, 128, 13843,
front-stage and 40, 138, 1412
use of models at 128, 130, 141
Barnesian performativity 613, 103, 126
Basel Committee on Banking Supervision (BCBS) 109
Beckert, J. 42, 55, 126
Bernstein, P. L. 30, 100, 120
Beunza, D. 26, 31, 92, 93, 96, 106, 107, 115
Black-Litterman model 98101
Black-Scholes model (BSM) 645, 67, 1212, 154
calibration 345
implied volatility 346, 46, 67, 88, 121
“making models count” 337
option pricing 23, 35, 49, 62
Blodget, H. 96
Bloor, D. 125
Bogle, J. 125
Boldyrev, I. 58
bonds, 152
contingent convertible bonds (COCOS) 424, 153
selling 43
valuation 434
Borch, C. 107, 115
Butler, J. 129
BSM see Black-Scholes model (BSM)
calculation 3033, 145
and judgment 3033
“calculative cultures” 69, 70
in risk management 104
“calculative pragmatism” 31, 69
calculative tools
Black-Scholes formula as 121
models as 3, 23, 45, 128, 145
Callon, M. 312, 51, 5965
capital asset pricing model (CAPM) 6, 99, 11921
capital guarantee product (CGP) 86
CAPM see capital asset pricing model (CAPM)
Cartwright, N. 82
CDOs see collateralized debt obligations (CDOs)
“chains of finance” 146, 154
Cochoy, F. 32, 71
COCOS see contingent convertible bonds (COCOS)
Colander, D. 58
Coleman, L. 119
collateralized debt obligations (CDOs) 2, 109, 122
communication devices, models as 11922
“communism of models” 149
consensus, plausibility check of 8992
consumptive regime of valuation 44
contingent convertible bonds (COCOS) 424, 153
selling 43
valuation 434
Coombs, N. 116
counter-performativity 645, 129, 141
“credible worlds” 50, 53, 556
credit rating agencies 6, 110, 11214, 127, 128
Croft, J. 111
cultures of model use 4, 7, 378, 49, 147, 152, 1545
DCF model see discounted cash flow (DCF) model
de Certeau, M. 102
decision-making, financial 45
as “acting sensibly” 2630, 50
as action-like 3, 29, 32, 38, 39, 4951, 66, 69, 86, 107, 126, 145, 148
calculation and qualculation 3033
credit rating agencies 11214
cultures of model use 667
discounted cash flow model 2023
diversity of models 10810
financial regulators, consequences for 11416
implied modelling 8893
as “incision” and “acting sensibly” 2630
judgment and 3033
“at large” 3840, 45, 154
nature of 1517
performative concept 102105
qualitative overlay see qualitative overlay
quantamental investing 7074
radical uncertainty 3
risk cultures 11012
theory and economics 14751
decision-selling, models in 45, 11719
communication devices 11922
failure of models as failure of performance 12931
persuasion routines 1234
theatricality 1247
useful fictions 126, 1279
see also decision-making, financial
de-idealization 535, 153
Derman, E. 2, 22, 120
Derrida, J. 27, 51
Deutsche Bank 43
discounted cash flow (DCF) model 757681, 128
application in wealth department 7783
fair value of assets 212
judgment and 823, 85
for portfolio managers 7681
problems with 2023
discount rate 21
diversity of model cultures 10810, 147
dividend discount model (DDM) 95
doing calculations 37, 38, 69, 143
earnings per share (EPS) growth 90
econometric forecasting models 75
economic forecasting 1323
backstage and front-stage 13840
role of surprises 1378
staging the “soft landing” in February 2008 1335
uncertainties and lack of knowledge 1357
economic models
credible worlds 55
de-idealization 545
idealization 534
effecting calculation 3033
efficient market hypothesis (EMH) 64, 66, 120
endogenous events 17
epistemic cultures 8, 51, 145, 146
epistemic practices 48, 60
error maximization problem 98
Esposito, E. 18, 19, 91, 107
ethics, finance and responsibility 1546
European Securities and Markets Authorities (ESMA) 127
exotic equity derivatives, modelling and trading 75, 868
failure of models, as failure of performance 12931
fair value of assets 212, 34, 66, 7677, 934, 967, 144
faith in markets 256, 42, 45, 125
false precision 123, 124, 14041
fictions 55, 118, 1256
production of 39, 412, 45
useful 1279
finance ethics 1546
financial decision-making see decision-making, financial
financial markets
creating faith in 256
ignorance studies in 1457
judgment in 814
as markets of “nobody knows” 1718, 412
“quasi-religious faith” in 25, 42
financial regulators, consequences for 11416
financial staging 14043
forex analysis, models and “views” in 75, 846
formal decisions 30, 151
Frigg, R. 55
front-stage
and backstage 40, 138, 1412
economic forecasting 13840
use of models at 4041, 44, 118, 12224, 128
Frydman, R. 149, 151
fund managers 90, 91, 100
fundamental investing 70, 72
fundamental managers 713
fundamental overlay 73
future cash flows 21, 22
Garud, R. 96
Gaussian copula formula 2, 65, 122
Gibbard, A. 81
Gill, M. 11516
Gigerenzer, G. 30, 150
Giorgi, S. 124
Goffman, E. 40, 123, 139
Goldberg, M. 149, 151
Goldman Sachs bank, risk management 112
Graaf, J. 38, 91, 131
Grinold, R. C. 89
Hägglund, P. 96, 97, 128
Hardie, I. 109
Haug, E. G. 33, 34
HBOS 11112
heuristics 9, 25, 27, 28, 30, 33, 104, 148, 150
heuristics of model use 37, 110, 150, 172
idealization 3, 47, 4950, 534, 56, 76, 108
ignorance studies, of financial markets 1457
illusions
of control 14043
of knowledge 1467
production of 412
imperfect knowledge 17
implied correlation 88, 122
implied modelling 74
backing out and see backing out modelling
implied probability 88, 923, 107
implied volatility 346, 46, 67, 88, 121
“incisions” 389
financial decision as 2630
informal decisions 30, 151
Institute for Supply Management (ISM)’s Manufacturing Index 1356
institutional decision-making process 104105
intuition 100, 114, 148
investment chain 45, 51
Jovanovic, F. 120
judgment 11214, 148
and DCF model 823, 85
and financial decision 3033
nature of 814
qualitative overlay 74
Kahn, R. N. 89
Kalthoff, H. 32
Karpik, L. 30, 32
Kay, J. 26
Keynes, J. 26, 54, 150
Klamer, A. 123
Knightian uncertainty 13840
Knorr Cetina, K. 49
Knuuttila, T. 57
Koen, B. V. 58
Kreiner, K. 25, 38
Lépinay, V. A. 75, 86, 87
Lockwood, E. 19, 110
MacKenzie, D. 27, 49, 6062, 64, 109, 121, 122, 126
“make-believes” 55, 125, 142
models as 128
“making models count”, Black-Scholes model 337
making sense 28
market expectations, backing out modelling 9091
markets
creating faith in 256
financial see financial markets
“quasi-religious faith” in 25, 42
markets of “nobody knows” 1819, 412, 128
Markowitz, H. 98, 99, 120
Mars, F. 95, 96
Mauboussin, M. J. 8990
McCloskey, D. 123
meaning finitism 27
mean-variance analysis 99
merger arbitrage traders, reflexive modelling in 923
methodological situationalism 10
Mikes, A. 69, 70, 104
Millo, Y. 61, 62, 64
Milne, F. 120
model deficiencies 7, 105
model dopes 93, 141, 143
model failure as performance failure 12931
model herding 1068
model influence, on markets 7, 61, 63, 69, 103104, 144
and society 9, 142
model misuse 105, 108
model overlay 72
model oversight 723
model risks 9, 13, 14, 105108, 141, 145
model use
in financial markets 4952
in science and technology studies 4951
models
as calculative tools 3, 23, 45, 128, 145
as communication devices 11922
in decision-selling see decision-selling, models in
failure of 12931
in finance, limitation of 7, 1820, 98, 122
as opinion proclaimers 74, 93, 112
Black-Litterman model 98101
securities analysts 947
as parts of persuasion routines 1234
as representations and idealizations in science 525
theatricality with 1257
as useful fictions 1279
see also decision-making, financial
modern portfolio theory (MPT) 98101
Morgan, M. S. 56, 81, 82
Morris, J. 116
Mouritsen, J. 25, 38
MPT see modern portfolio theory (MPT)
Muniesa, F. 312
non-analytical decision-making 28
non-knowledge 3, 15, 178, 24, 27, 29, 48, 67, 1447
cultures of 147
in financial markets 1718, 1447
staged as knowledge 3941, 137
Nowak, L. 54
opinion proclaimers
models as 74, 93, 112
Black-Litterman model 98101
securities analysts 947
securities analysts 947
option pricing 23, 35, 49, 62
Black-Scholes model 62
“over-calculative view” 15
Penét, P. 113
performativity 14, 47, 512, 6063, 656, 103
Barnesian performativity 613, 103, 126
counter-performativity 645, 129, 141
critiques of 635
as performative practice 65, 102
processual nature of 634
social studies of finance and 613
weak forms of 62, 103
perlocution 1247, 129, 130
persuasion routines, models as 1234
persuasive communication devices, models as 11922
plausibility check of consensus, in portfolio management 8992
Porter, T. M. 1516, 40, 117
portfolio management, plausibility check of consensus in 8992
portfolio managers 20, 21, 39
backstage forecasting 138, 139
DCF model for 7681
Power, M. 31, 67, 69
practical endeavour, science as 579
pragmatic modelling 559, 65
pragmatic turn 13, 559
Preda, A. 49
probabilistic models 1819
processual concept of performativity 634
pseudo-knowledge 146
qualculation 3033, 69, 115
qualculation devices 32
qualitative overlay 745, 105, 137
discounted cash flow model 75, 7681
exotic equity derivatives, modelling and trading 75, 868
foreign exchange (forex) forecasting 75, 846
judgment in financial markets 814
quantamental investing 7074
quantitative managers 7072
“quasi-companies” 1279
in securities analysts 967
“quasi-religious faith”, in markets 25, 42
radical uncertainty 16, 19, 235, 30, 32, 39
see also Knightian uncertainty
Rappaport, A. 8990
RBS see Royal Bank of Scotland (RBS)
recession 1346
reflexive modelling, in merger arbitrage traders 923
Reiss, J. 53, 55
responsibility ethics 1546
restorative regulation 115
reverse brokering 912, 131
reverse optimization approach 100
risk 2, 15, 16, 19, 30, 39, 43, 69, 99, 146
endogenous risks 16, 147, 149
model risks 9, 13, 14, 105108, 141, 145
systemic risks 16, 99, 107, 156
risk-free rate 119
risk management 10, 69, 104, 11012
calculative cultures in 104
cultures of 11012
“weak risk culture” 111
risk models 2, 19, 64, 104, 109, 116
risk premium 21, 22, 119
for emerging markets 77, 79, 80
Roffe, J. 34
Royal Bank of Scotland (RBS)
investment estimate 91
contingent convertible bonds 43
Savage matrix 10, 15, 33, 149
science and technology studies (STS) 8, 12, 46, 47, 48, 60, 148
model use in 4951
science as practical endeavour 579
Searle, J. 125
securities analysts 947, 124
“fair” value of company 94, 96
as modellers and price forecasters 94, 95
target price 946
“sell side” 40
sense-making 28
Shackley, S. 41
Sharpe, W. 99
Shiller, R. 5
Smith, C. W. 28
social studies of finance (SSF) 4, 810, 1214, 27, 31, 469, 512, 6061, 74, 119, 123, 147, 151
“soft landing” in February 2008 1335, 140, 141
Sornette, D. 99
Spears, T. 49, 64, 121, 122, 154
SSF see social studies of finance (SSF)
staging of illusions of knowledge 145
Stark, D. 10, 26, 31, 923, 106107, 115
strategic ignorance 1467
STS see science and technology studies (STS)
Sugden, R. 55
symmetrical ignorance 13, 18, 41, 144, 145, 149, 155
Taleb, N. 2, 17, 33, 34, 99, 105, 148
target price 945
ten-year US Treasury yield 136
theatricality with models 1247
Toon, A. 55
Triana, P. 35, 73, 105, 111
trust in models 9, 22, 44, 69, 78
trust production 126
Tuckett, D. 123
UBS bank 43
uncertainty 1516, 20, 128
neglect of 135137
“under-calculative view” 245
“undoing calculations” 37, 38, 69, 143
see also doing calculations
unrealisticness of models 534, 120
useful model fictions 126, 1279
Ushakov, A. 58
valuation models 22, 48, 76, 86, 956, 128, 1524
valuation regimes 1523
valuation studies 1524
Value at Risk (VaR) model 2, 6, 18, 6911012, 141
critique of 2, 18
van Daalen, C. E., 56
VaR model see Value at Risk model (VaR) model
Varian, H. R. 81
volatility
implied 346, 46, 67, 88, 121
of returns 99
volatility fudging 35
volatility smile 36
Walton, K. 55, 125
Wansleben, L. 84, 139
“weak risk culture” 111
Weber, K. 124
Weber, M. 15
Weick, K. 289, 86
Wittgenstein, L. 151
Zadeh, L. 50
Zaloom, C. 323
Zuckerman, E. 63, 64, 66