April 24, 2017

A regulator’s rational risk aversion when mounted on top of that of the bankers, produces an irrational risk aversion

Sir, John Authers when commenting on Andrew Lo’s “Adaptive Markets” writes: “our susceptibility to judge risks incorrectly is rooted in the necessities of survival. Fear, our early warning system, makes us irrationally averse to loss. We run greater risks to avoid a loss than to make a profit. “An emotional way to look at market theory

Indeed, just look at bank regulators.

Even though bankers, because of their rational loss aversion, never create excessive and dangerous exposures to something ex ante perceived as risky, the regulators, with their risk weighted capital requirements for banks, mounted their rational aversion to loss, on top of that of the bankers’, and so it all became an irrational aversion to loss.

If the father’s and the mother’s average risk aversion is used educating their children, these will turn out well. But, if it is the sum of the father’s and the mother’s risk aversion that becomes applied, then their kids are lost... they will dangerously go too much for what is safe, and dangerously too little for what is risky.

In other words, the efficient markets hypothesis, the rational utility-optimising “homo economicus”, has no chance of working efficiently when interfered by regulations produced by some hubris inflated homo distorters.