James R McLean has written a fairly coherent piece on my challenge to Michael Emmet Brady. He has also given me a rather nice point of departure with which to make my case against Brady. He has done so by providing a misinterpretation of Freudian theory — something which, as readers of this blog will know, tickles my fancy somewhat. So, I should be able to kill two birds with one stone; one being what I see to be Brady’s grandiose claims and the other being a misunderstanding of Freudian theory.
Regarding Freudian theory McLean writes:
One is that any theory about human behavior could be, to the same degree, accused of tacitly assuming that everyone it purports to describe “knows” the theory. Freudian psychology, likewise, “assumes people have first read and understood Freud”—for surely, for someone to make decisions in line with Freud’s work on psychology they would have to have first read and understood this work.
This is in response to my claim that Brady’s decision theory relies on the implicit assumption that people have read either Brady’s work or Keynes’ Treatise on Probability (and interpreted the latter in the same manner as Brady). Thus, for McLean such a complaint “does not work as a rebuttal”. The problem with this? McLean’s reading of Freudian theory is wrong.
Freudian theory, in fact, does make claims that people will act in line with said theory despite not understanding it. In point of fact, since the popularisation of Freud many psychoanalysts have complained that peoples’ superficial understanding of his work has made their job a lot tougher because everyone tries to vulgarly interpret their own symptoms and dreams and this detracts from the analyst’s ability to do so. (This is somewhat similar to the contemporary doctor’s complaint about people who try to self-diagnose using online sources).
Let me take a recent example I came across which shows how Freudian psychology can be used to understand aspects of peoples’ desires and actions despite their not understanding said psychology. From there we can then go on to show why Brady’s theory of decision-making is no such thing.
Some time ago I was talking to a girl I know. The conversation turned to children being influenced by a certain cultural trend. She said “why would I care if my children were influenced by…” said trend. She then quickly bit her tongue and said, “I mean why would anyone care that their children were influenced by…” said trend. The girl in question did not have any children, of course. A Freudian would conclude that her slip of the tongue manifested a desire to have children and that perhaps this was what was going through her subconscious mind at the time of the conversation.
In fact, this should be fairly obvious. Slips of the tongue always have such meanings. They manifest desires on the part of the person doing them that either they do not consciously recognise or they are trying to keep hidden for whatever reason. In this way Freudian psychology can tell us things about the people despite these people not being aware of Freudian psychology — something I can confirm about the girl in question. That is what makes the theory useful.
Something similar can be said of decision-making theories in economics. Take the Efficient Market Hypothesis (EMH) as an example. The EMH tells us that, given what it claims about how people make decisions, an individual investor cannot persistently beat the market. If we believe this theory — which, by the way, I do not but that is irrelevant to this discussion — then we can take investment advice from it: we would buy into index funds that track the market. The EMH does not rest on the assumption that everyone in the market understands and adheres to the EMH. That is what, in the view of its proponents, makes it a useful theory.
Or take the competing theory: behavioral finance. Behavioral finance also purports to tell us information that we can use in the real world. As the popular manual on technical trading Technical Analysis: The Complete Resource for Financial Market Technicians puts it:
Behavioral finance is a quickly growing subfield of the finance discipline. This branch of inquiry focuses on social and emotional factors to understand investor decision making. Behavioral finance studies have pointed to cognitive biases, such as mental accounting, framing, and overconfidence, which impact investors’ decisions. These studies suggest that investors act irrationally, at times, and can drive prices away from the EMH true value. Investor sentiment and price anomalies, either as trends or patterns, have been the bulk of technical analysis study. Sentiment and psychological behavior have always been the unproven but suspected reason for these trends and patterns, and human bias has always been in the province of trading system development and implementation. (P49-50)
Again, behavioral finance does not assume that everyone in the market need understand behavioral finance in order for it to produce valid results about human decision-making. This is, like the EMH or Freudian psychology, what makes it a useful theory in the eyes of its proponents; it is the fact that it can purportedly tell us something about what makes people tick regardless of whether they understand the theory or not that provides us with relevant and useful information.
This is the question I raised with regards to Brady’s decision theory: can it provide us with such useful information? If it can tell us how people will behave then we should be able to better understand financial markets with it — after all, this is what rival theories like the EMH and behavioral finance purport to do. If this is, in turn, the case then Brady or someone who is familiar with his theories, should be able to lay out a manner in which we can apply the theory to financial market data — again, this is what proponents of the EMH and behavioral finance actually do with these theories.
The problem with Brady’s theory is that I do not believe that it is such a theory of decision-making. Rather I think that it pretends to be but is actually something rather different; it is actually an idiosyncratic probability theory that really tells us nothing useful about how people make decisions. In this sense, Brady’s theory is useless.
McLean, who seems like a thoughtful person, actually gave this some consideration when he wrote at the end of his piece:
So James, in what sense is Michael Emmett Brady circulating a useful decision theory? In what sense does it have something to say about the real world? And I would have to say that Mr. Brady has always discussed its value in the realm of public policy…
The problem with this? He never specified the novel insights that Brady’s theories give us with regards to public policy. Do Brady’s theories give us insights that standard Post-Keynesian theory cannot regarding public policy? I have certainly not been made aware of such insights. But even if they do exist, Brady’s theories are still not what they claim to be; that is, decision-making theories in the proper sense of the term. And that is my fundamental problem with them.
Where I disagree with the EMH and am cautiously skeptical of the claims of behavioral finance, I nevertheless recognise that they can actually be applied to the real world — and thus falsified. No one has shown me that Brady’s theories can be. And that is my fundamental problem with them. I don’t believe there is any there there; I believe Brady’s theories to be basically empty. They make the claim to be a theory of human decision-making, but no one has shown me how they can be applied to study human decision-making.