Tag Archives: David Stark

On the Limitations of Behavioral Finance

Behavioral finance has exploded in popularity not just because it’s interesting—regular finance is interesting, too—but because it combines that interest factor with an abundance of what one scholar called “descriptive charm.”

There is something strangely entertaining in reading about the economic foibles of others: one part schadenfreude,  plus one part abashed recognition of one’s own past mistakes—mixed with quiet relief to find oneself  with lots of company in making those mistakes.

Plus, it gives many of us readers great stories that to tell at dinner parties. Being able to talk about the myth of the “hot hand” in basketball, or investor preferences for cash versus stock dividends, can make for a pretty entertaining evening in some circles.

Reading behavioral finance can also provides a sense of Finally Understanding How Things Work when it comes to money and markets. Learning about common cognitive errors in economic decision making, such as “anchoring,” and “availability bias,” feels like getting a peek inside the flawed machines that are our brains, making it seem possible to predict the behavior (particularly the mistakes) of others, and guard against them in oneself. In short, behavioral finance seems to offer insight and a sense of control, imposing order on what otherwise appears chaotic and unpredictable.

But a dozen years after my own personal infatuation with behavioral finance began—by devouring Richard Thaler‘s classics, Advances in Behavioral Finance and The Winner’s Curse—a number of limitations have become obvious.

All research programs have limitations, of course. But those of behavioral finance undermine its purpose: that is, to enhance understanding of financial markets and investor behavior. Others have written eloquently on this subject, particularly Daniel Beunza and David Stark, and John Y. Campbell. What I have to add to this ongoing debate boils down to two points and their consequences:

    1. Failure to acknowledge the findings of the allied social sciences
    One of the cardinal laws in scholarship is to acknowledge the work of others and avoid reinventing the wheel. But when you read works of behavioral finance, you’d never know that deviations from rational, self-maximizing behavior are old news in psychology, political science, sociology and anthropology. Check the references section of a behavioral finance article or book and see how many citations from those fields you can find. Chances are, there will be zero. Behavioral finance scholars generally cite each other, or work from mainstream economics and finance.
    This is particularly strange since so much of contemporary behavioral finance depends on the contributions of social psychologists like Daniel Kahneman (a 2002 Nobel laureate for his work in behavioral finance) and the late Amos Tversky, as well as much older work by people like Herb Simon, who was a Professor of Political Science and Industrial Administration at various points in his career. Simon won the Nobel Prize in economics for work done half a century ago on “bounded rationality“—a concept closely tied to many of the key phenomena examined by behavioral finance, but which is virtually ignored in their publications.
    While a lot of academic research speaks to a rather small group of other academics, behavioral finance is distinctive within the social sciences for restricting its scholarly conversation so tightly. This isn’t the case in the closely-related disciplines of economic sociology, neo-institutionalist political science, and economic anthropology, all of which regularly cite and engage with one another, to the enrichment of all.
    In the case of behavioral finance, reluctance to acknowledge the many research interests it shares with the allied social sciences may be part of the larger project of rigid separation and boundary enforcement that has been carried out by economists since the time of Pareto. This has created what Schumpeter described as a regime of “mutual vituperation” which has kept economics and finance in a state of self-imposed incommunicado with sociology, limiting the advancement of knowledge on our shared interests. Behavioral finance, it seems, is sticking to the party line on this point.
    2. A narrow, limited critique of economic theory
    Cataloging the many ways humans fail to think rationally about money, investments and risk is a good start. But in most ways, behavioral finance leaves intact the problematic assumptions of traditional finance, pulling its punches, so to speak. Among the most noteworthy examples:
    a. Behavioral finance remains stuck at the individual level of analysis
    As in traditional finance and economics, the object of inquiry in behavioral finance is the individual—despite rafts of evidence going back decades that individuals don’t make decisions about money, risk or investing in a vacuum, but as a result of social influences. Of course, this evidence comes from those allied social sciences that are being so studiously ignored. For example, economic psychologist George Katona showed 35 years ago that most people choose investments based on word of mouth recommendations from their friends and neighbors. This influence of social forces in economic decision-making has been demonstrated with equal or greater impact among finance professionals—for instance, in a study of Wall Street pension fund managers by economic anthropologists O’Barr and Conley, and more recently in a sociological study of arbitrage traders by Beunza and Stark.
    In the past, there were encouraging signs that behavioral finance might break through the limitations imposed by sticking to the individual level of analysis, most strikingly in Robert Shiller’s 1993 statement that “Investing in speculative assets is a social activity.” But thus far, the implications of such statements, and the plethora of evidence supporting them, remain unexplored.
    b. Behavioral finance limits itself to pointing out failures of cognition and calculation
    As important as those factors are in distorting financial decision-making, there are a host of others that we know about—based on research in those allied social sciences that behavioral finance doesn’t acknowledge—that are excluded from research in behavioral finance. This includes emotions, and social phenomena like status competition, both of which play a significant role in the findings of economic sociology, psychology and anthropology. The cognitive/calculative failures may interact with the socio-emotional phenomena, but we won’t know as long as behavioral finance pretends the latter don’t exist. That’s a loss for all of us interested in markets, money and investing.
    c. Behavioral finance doesn’t explain how individual acts and decisions produce aggregate outcomes
    As a consequence of keeping the analytical focus on individuals—avoiding the social and interactive aspects of economic activity—behavioral finance doesn’t have the theoretical means to address mechanisms through which individual acts and decisions aggregate. That means it can’t explain institutions and other manifestations of collective behavior which form the context for all the individual behavior it examines. Of course behavioral finance can’t answer all questions about money and markets, but it ought to be able to explain what happens when hundreds, or hundreds of millions, of people fall prey to the “hot hand” fallacy or availability bias? If behavioral finance won’t touch questions like that, who will?

The consequences for ignoring the other social sciences and mounting a very narrow critique of traditional finance and economics, include:

  • Limited predictive power
    Behavioral finance tells us more about what people won’t do (e.g., behave according to notions of rationality outlined in economic theory) than what they will do.
  • Contradictory implications
    Are investors risk-averse or overconfident? How should we reconcile seemingly contradictory findings like these? Behavioral finance doesn’t tell us, because of its…
  • Failure to offer a viable alternative to the theories it challenges
    Pointing out all the ways that real life behavior doesn’t bear out the predictions of traditional economics and finance is interesting—even fascinating, at times—but it’s not an alternative theory. “People aren’t rational” isn’t a theory: it’s an empirical observation. An alternative theory would need to offer an explanation, including causal processes, underlying mechanisms and testable propositions.

All this keeps behavioral finance dependent on traditional economics and finance rather than allowing it to grow into a robust theoretical realm in its own right. Perhaps someday the field will develop into something more truly challenging to economic orthodoxy. Until then, behavioral finance will have to play Statler and Waldorf to the Muppet Show of mainstream finance—providing entertaining critique, but not replacing the marquee acts. (Now if economics would just substitute Milton Berle for Milton Friedman….)

A Tale of Two Simulacra: Market Meets Jersey Shore

Proof that the world will end not with a bang but a whimper: Snooki saying "Waaah."


The S&P Styling Product Index surged higher on Tuesday as the cast of MTV’s “reality” show, The Jersey Shore—including noted economist J-Doww—rung the opening bell at the New York Stock Exchange.


No, seriously! This quasi-apocalyptic event actually holds some interest for economic sociology.

In what may be the ne plus ultra of performative economic action, a group of young people who make their living performing* obnoxious ethnic, class and gender stereotypes appeared on one of the world’s great stages for performing the capitalist market economy.

The event seemed to be greeted with universal dismay, from observers who found the Jersey Shore cast to be insufficiently “true” to their on-screen selves (?!?), to those who saw their presence at the Exchange as a kind of sacrilege, judging by reaction on the NYSE’s Facebook page.

I’d like to suggest that what seems so wrong with that picture of Snooki and company ringing the opening bell actually makes a lot of sense sociologically. If this meeting of worlds—entertainment and the stock market—seems strange, it may be because we’re so used to regarding the markets as “real,” rather than as a performance (or even as entertainment in their own right).

But sociological researchers are building the case for treating markets as no more “real” than “reality TV.” As Michel Callon has written, “economics . . . performs, shapes and formats the economy, rather than observing how it functions” (1998: 2). This theme of economists creating markets was picked up and elaborated by Donald MacKenzie and Fabian Muniesa, who argued persuasively that by describing and predicting market behavior, economists create self-fulfilling prophecies (Merton 1949), thus performing the markets they claim to observe as outsiders. As an example, the idea here is that when economists—or the chief economist of the United States—says the American economy is in recession, it becomes so.  The statement makes the situation real rather than conjectural.

Which brings us back to The Situation and friends. Perhaps the most troubling aspect of their appearance at the NYSE is not their incongruity, but how very much they belong there. As performers famous for simulating reality, they have something important in common with economists who perform markets by stimulating the reality they purport to describe.

Both are engaged in producing what French sociologist and cultural theorist Jean Baudrillard calls “the simulacrum:” a copy without an original, a pretense that replaces and ultimately negates “reality” so successfully that we no longer care about what is real.

One sort of simulacrum is the “referent:” someone or something that represents something else, as the cast of The Jersey Shore is purported to represent a segment of American society. Another sort of simulacrum—the dominant type in a post-industrial age—is the model, which becomes more real than the reality it supposedly represents. And model-creation, particularly the development of models that reframe a messy reality in clean and elegant terms, is a specialty of economists.

When Baudrillard said of the simulacrum,

It is no longer a question of imitation, nor duplication, nor even parody. It is a question of substituting the signs of the real for the real… (1994: 2)

…he could have been writing the job description for the Jersey Shore castmates, as well as for the economists whose declarations of recession and recovery animate the markets.

In fact, Baudrillard foresaw the collision of the entertainment and economic spheres through their shared use of models and representations to supplant reality. His body of work, starting with Simulacra and Simulation in the early 1980s and continuing through Impossible Exchange in 1999, implicates Wall Street and academic economics in the same project as Disneyland and Hollywood.

The pageant of the Chicago Mercantile Exchange, produced by artist Andreas Gursky.

Theorized in this light, the market isn’t just performative, but a performance produced for our entertainment—an idea explored visually by artists such as Andreas Gursky and Burak Arikan. Economic reports and analysis thus become part of what Baudrillard’s contemporary, Guy Debord (a founder of the Situationist movement, appropriately enough), termed The Society of the Spectacle:

The language of the spectacle consists of signs of the ruling production, which at the same time are the ultimate goal of this production…The spectacle subjugates living men to itself to the extent that the economy has totally subjugated them.

Theorized through this lens, the image of the Jersey Shore cast ringing the opening bell at the NYSE persists in memory not because it is represents a collision of worlds, but because it brings together two genres of performance whose entertainment value depends on their purported “reality.”

Seeing the two juxtaposed underscores the illusory nature of both types of performance—the “guidos” and “guidettes” appear out of character, exposing their Jersey Shore personas as characters, and suggesting that the NYSE is just another kind of stage. The effect is similar to the “Funny or Die” episode entitled “The Real Jersey Shore,” minus the reassuring label of parody:


* Their range as performers was showcased in the epic drama “Friggin’ Twilight:”

The Sense of Dissonance–An Interview with David Stark

After writing last month’s post about what I learned from David Stark about performativity, I decided to pick up his new book, The Sense of Dissonance. Stark’s ideas about the value of play, ambiguity and uncertainty seemed to hold a number of important implications for research and education on economic issues. So I thought it would make an interesting blog entry to interview one of the foremost contemporary sociologists about his work. In the dialogue that follows, we discuss what inspires Stark’s research, and the lessons his book holds for practitioners and scholars.


Not a good metaphor for heterarchy, unfortunately.

Brooke Harrington: As someone who gives a prominent place to art and imagery in your research, do you have a visual metaphor for heterarchy? As I read The Sense of Dissonance, I formed a mental image of heterarchy as a kind of layer cake, in which the layers are orders of worth: the orders coexist, bound together by “frosting” to form a coherent social system. As soon as this image came to me, I wondered: what does heterarchy look like in your mind’s eye?

David Stark:: I had thought about metaphors while writing the book. That’s why I put three epigraphs at the book’s opening.

The first is from Dante, a passage from the Purgatorio of The Divine Comedy: “Fix not that mind on one place only.” I think it well expresses one of the core ideas of the book. A critical challenge of organizations in rapidly changing environments is the problem of getting trapped in your own successes. Heterarchies – organizations with multiple evaluative principles – are better able to avoid this cognitive lock-in because they are always looking out of multiple frames.

I allude to the Dante passage in the Preface where I briefly mention a sociological double vision. I like this notion. Of course, double vision is a kind of malady, things are out of focus. But “focus” can be overrated, especially if it’s the single-minded variety.

We so often hear advice, whether it is to organizations or, for example, to our students: “Get focused!” But, continuing with this visual metaphor, there is also something to be said about the importance of peripheral vision. It’s critical for athletes. It’s a useful and necessary skill for moving very quickly together with many other people, going in different directions, as I’ve been aware when navigating from one subway line to another during rush hour in the Times Square subway station. And it’s vital for organizations. If the strategy horizon is foreshortened, meaning that the future is not far away and it is highly unpredictable, then you should not be locked-in looking ahead but must also be attentive to the movement that is happening around you. Peripheral vision achieves awareness of that movement.

In personal terms, then, in thinking about advising students, we mustn’t neglect the “stay focused” part because there are serious dangers in flitting from topic to topic, a kind of attention deficit disorder. But if the injunction is limited to one, the better might be something more like, “be attentive” or “pay attention.” You can look in more than one place, but the goal to keep in mind is to be attentive to the real insights that are possible when both are held in view.

Brooke: What about the other two epigraphs?

David: If the first was a classic, the second is from pulp fiction. And whereas the first is from the Purgatorio, the second is from the Elmore Leonard’s crime novel, Mr. Paradise: “A good detective doesn’t know what he’s looking for until he finds it.”

Following on that line, the introduction of the book opens with the problem of search. But the critical search is not when I already know what I’m looking for. Search engines can do this. Instead, the more interesting search is when I don’t know what I’m looking for, yet I can recognize it when I find it.

Each side of the statement is important. As for the first, with John Dewey I’m interested in open-ended inquiry, in which the biggest challenge is less the analytic one of problem solving than the interpretive one of identifying the problem. On the second side, there are the moments of recognition. The challenges of innovation, whether in business, the arts, or science is be able to recognize the novel possibilities, and to be able to formulate them in ways that are recognizable by others. The more the innovation is outside existing categories, the greater the challenge.

Brooke: And the third epigraph, from William Carlos Williams?

David: That’s from his 1951 poem, Patterson:

if you are interested
leads to discovery.

This is a wonderful passage, and I like it so much. To recognize the accomplishment, one first has to be attentive to the poetic elements of the sounds themselves. You’ll need to read it aloud. Try it and you’ll hear. Dissonance if you are interested leads to discovery. It’s all consonance and assonance. As a result, the dissonance of the passage is not in the literal meaning of the words but in the discrepancy between the words and the formal elements. The words go one way; the sounds go another. The passage does what it says when you hear it in two simultaneous and dissonant voices.

In your initial question you asked, “what does heterarchy look like in your mind’s eye?” For me, it’s probably more the case of what heterarchy sounds like in my mind’s ear. There is an overarching metaphor of the book, which after all is right there in the title: The Sense of Dissonance. The metaphor is musical, polyphony. There are multiple voices, and they are not harmonious. Yet there can be a sense in this dissonance.

I would love to eat your layer cake for dessert, but it might be too sweet to be the metaphor that I would adopt. First, the notion of layers is a bit too flat. True, each order of worth is relatively discrete. Each is principled, and the principles are incommensurable across orders. Yet the layer cake metaphor misses the interaction among them. The musical metaphor of multiple voices gets at this interaction.

Diversity matters – in business organizations, in our universities. But if the diverse elements stand indifferently apart, there will not be innovative recombination. In the concluding chapter of the book, I address this in reference to organizational ecology which correctly pointed to the importance of the diversity of organizations. My work points to diversity within organizations, and even more pointedly to the organization of diversity. It’s laughable if taken literally, but I noted that organizational ecology lacks sex. What’s missing is the notion of cross-fertilization.

As the second point of difference from the frosting of your layer cake: the interaction among orders of worth is not smooth. Hence the concept of generative friction, another metaphor that appears throughout the book. From Oliver Williamson we got the message that friction is bad, smooth is better. I was immunized against that message by the notions of the designer capitalists who flew into the former Soviet bloc after 1989 with their recipes, formulas, and marching orders for a “smooth transition.” Frictionless notions also abound in pop sociology adages like, “Let’s all get together and iron out our differences.”

The metaphor of dissonance displaces the commonly-held idea that coordination is all about our shared understandings. True, here as with the notion of focus and attention, organizations cannot cohere if there is absolutely no shared sense of purpose. But musical pieces can have beautiful, meaningful dissonance. Take, for example, the mature work of Charles Ives in which the overlapping of discordant musical themes – as when in “The Fourth of July” the orchestra splits into two marching bands that come crashing towards each other – creates extraordinary, and extraordinarily beautiful, dissonance.

It’s for these reasons that I titled the book The Sense of Dissonance. I sensed that the reader would see that there can be sense – reason – in the dissonant clash of heterogenous performance principles. I hoped that a few might also connect to an additional connotation that organizations might vary in their ability to have a sense of dissonance, not directly analogous to the senses of sight or hearing but more like how individuals can vary in having a sense of self, or even better, a sense of humor.

Brooke: Your description of the value of play in organizations—in the context of playing with ambiguity (p. 185 in particular)—offers a distinctive take on innovation strategy. How could someone working in a business organization apply those insights? In other words, how does one organize to promote play and thus innovation?

David: Play is hard work. Take writing, for example. I’ll sometimes try to exploit the polysemic character of terms in which there are multiple connotations operating at once. Think of accounts (narrative and book keeping), performance (a skilled staged activity and a metric), demonstrations (technical, commercial, or political with very interesting interplays among them), or the difference between two words in which one is seemingly the plural of the other – value and values. But I never think about this as “playing with words.” It’s working with words. Writers who make words work overtime should give them due recognition, as Humpty-Dumpty says in Alice in Wonderland, “When I make a word do extra work, I’m always sure to pay it very well.”

"When I make a word do extra work, I'm always sure to pay it very well."

I’m not sure that I write about “playing with ambiguity.” Perhaps there is such a phrase in the book. But more frequently I write about keeping ambiguity in play. That can take some effort. There is productive friction; but friction can also come in destructive forms. The difference is that whereas the latter is personalized and frequently petty, the former is principled. But that doesn’t mean it has to be played out in deadly seriousness.

Brooke: By the way, your description of the trading floor in Chapter 4 was strikingly reminiscent of a place where we’ve both spent a lot of productive, intellectually innovative time: the Santa Fe Institute think tank. That might be surprising to readers who take the view that academia (including think tanks) is a world apart from business, and never the twain shall meet. Can you comment on the links—or at least the potential linkages—between the two arenas?

David: SFI is an excellent example. Take first the intellectual architecture as a place where many people are working in multiple registers. Lunch time throws together people from all over the disciplinary map. And not only that, but the typical introduction is frequently something like “I’m from physics but I’m working on this problem in biology.” Or, “I’m in biology and I’m working on this problem in computer science.”

And then there is the physical architecture, as close to an open plan layout as any I know about in academia. Some smaller offices, but much of the work taking place in the common spaces, with folks writing equations on the windows. It’s not an accident that there are family resemblances between SFI and innovative businesses. Among those who had a decisive voice in the design of the new space that was opened around 1998 were not only the resident scientists (and the “external faculty”) but also major donors who had made their mark in Silicon Valley. They had a strong sense of serious play.

Brooke: In the book’s concluding chapter, you draw out some methodological implications of your work on strategic ambiguity, foregrounding the value of ethnography for studying situations—the locus of reflexive cognition and innovation through “play.” This may be surprising to those who know of your work through the series of articles you’ve published in the most prominent journals in sociology using quantitative analyses (most recently in the January 2010 issue of the American Journal of Sociology). As one of the few people in our field who have successfully straddled the quantitative/qualitative divide, how would you respond to those who question the contribution of ethnographic methods to social scientific knowledge? What value does ethnography add in a field where quantitative methods are increasingly dominant?

David: Yes, working both in ethnography and network analysis is probably an example of following Dante’s dictum of not locking into a single strategy. If those efforts have been successful, it is because I have been able to work with very talented collaborators. It was wonderful to do field research with Monique Girard in the Silicon Alley new-media startup and later in our project on socio-technologies of assembly. Daniel Beunza has to be one of the most gifted ethnographers in the field. He’s a keen observer, and no one writes better field notes. Balázs Vedres is a brilliant network analyst, never shying from a challenging theoretical problem, and making innovative methodological advances with every new project. Writing, revising and resubmitting, revising and resubmitting again… it could be a pain but with Balázs it’s really been a source of enjoyment.

You ask about the value of ethnography. The good ethnographer is inquirying, precisely in the Dewian sense. If there is something common to all good ethnography it is that one does not start out knowing what one is looking for. That’s a rule, the first. And then there are rules of method about the conditions under which one can conclude that some practice has been recognized.

Because, at some level, science is not about making truths but about opening up the terrae incognita, the inquiring posture of a good ethnographer and a good quantitative analysis are not so very different. Accordingly, there are skills that are fungible across the research techniques. At one moment while we were doing the preliminary analysis working deep into the data for “Social Times of Network Spaces,” Balázs excitedly interjected “You’re doing ethnography of the data.”

In the last chapter of the book, I do advocate moving from the study of institutions to the study of situations. Ethnography is especially well-suited for analyzing situations. Not trivially, it is done in situ. It’s there – in the spaces and places where people live and work – that people make sense of their world and where we can get a sense of the important issues. It’s in perplexing situations that we can recognize what counts. If economic sociology is about the study of worth (not only in business but in many realms of life), that seems to be a good place to be.

Parsing Performativity

Performativity is becoming one of those terms that every economic sociologist—if not every sociologist—has to know. Unfortunately, it can also be difficult to grasp, as evidenced by the variety of attempts to explain it, from the highly-regarded work of Michel Callon, along with Fabian Muniesa and Donald MacKenzie, to the more informal (but very insightful) accounts available in the blogosphere.

J.L. Austin, linguistic philosopher and father of "performativity."

To my own great vexation, I suffered for a couple of years under some sort of mental block about the term. I understood performativity in its original context, in the work of linguistic philosopher J. L. Austin, who observed that language can do more than simply state facts: it can also be a kind of action. Statements such as “I dub thee Sir Galahad, Knight of the Round Table” doesn’t describe a condition, but instead makes something happen. Austin called these “speech acts” performative utterances.

So far, so good. But once scholars in other fields—including gender and queer theory, as well as sociology—adopted the term to their own ends, I lost the thread of meaning. Every time I learned what performativity was supposed to mean in economic sociology, that knowledge promptly got dumped out of my short term memory buffer rather than going into long-term storage. Then I’d have to start all over again.

And then I was lucky enough to hear David Stark give a short lecture in Paris last summer—at the annual meeting of the Society for the Advancement of Socio-Economics—and he solved my performativity problem just like that. His explanation was so elegant and concise that I wrote it on a Post-It note and put it up on my office wall. The Post-It reads:

If you show someone a map and say ‘this is how people get from Point A to Point B,’ the statement is performative when it creates the behavior it describes. In this case, a path gets worn in the ground between Point A and Point B.

Thus, performative statements don’t reflect reality (as in the declarative statement ‘this is a pen’), but intervene in it. Performative language is an engine, not a camera.*

A model becomes performative when its use increases its predictive capabilities.

—David Stark, Paris, 17.07.2009

The elegance of this statement still delights me. It’s like the Gettysburg Address of sociology in terms of its parsimony.

This doesn’t entirely capture what was so compelling about Stark’s presentation, however. The missing piece is the visual: images of a path, drawn first as a set of directions, and then as a description of actual travel routes. Every time I saw the Post-It, it called up those images from Stark’s presentation, but I couldn’t easily convey the images to others.

So I asked if I could post the original presentation slides that were such a revelation for me. Stark graciously agreed, so here are the core ideas of his talk in three images, forming what he has elsewhere called a “silent lecture.”

By way of context, assume that you start with a location, as in slide 1; then someone asks for directions through that location, resulting in slide 2, and ultimately slide 3.


* Stark borrows the phrase from the title of a well-known book by Donald MacKenzie.