George Soros on financial crisis

按:以下是筆者閱讀索羅斯的The New Paradigm for Financial Markets之筆記。

1. Central idea of Soro’s philosophy : how reflexivity can be observed in financial markets

1.1 The concept of reflexivity in a nutshell – market can never reach an “equilibirum” since there are inherent misjudgements and misconceptions made by market participants. Their misjudgements / misconceptions affect market places in turn, so the prices never reflect “its real values / expectations”.

1.2 The “super-bubble” theory – a long-term reflexive process which proceed over 25 years.

“the previous crises served as successful tests which reinforced the prevailing trend and the prevailing misconception. The current crisis constitutes the turning point when both the trend and the misconception have become unsustainable” (The New Paradifm for Financial Markets – The Credit Crisis of 2008 and What IT means, Introduction, x).

1.2.1 The basis of “super-bubble” theory: the imperfect match between one’s understanding and reality

“Our understanding of the world in which we live is inherently imperfect because we are part of the world we seek to understand” (chap1, p.3).

1.2.2  There are two functions where a man’s  imperfect understanding interact with reality.

  • cognitive function – to understand the world and acquire the understanding as knowledge
  • manupulative function – to change the world as well as their current situation

1.2.3 When these two functions operate in isolation, i.e. observations can be isolated from observant’s intentions or expectations, observations can be acquired as knowledge. If the two functions interfere with each other, observations can only be classified as biased perceptions since there is an inherent indeterminancy introduced into the course of events.

“When both functions operate simultaneously, the phenomena do not consist only of facts but also of intentions and expectations about the future. The past may be uniquely determined, but the future is contingent on the participants’ decisions. Consequently the participants cannot base their decisions on knowledge because they have to deal not only with the present and past facts but also with contingencies about the future. The role that intentions and expectations about the future play in social institutions sets up a two-way connection between the participants’ thinking and the situation in which they participate, which has a deleterious effect on both: it introduces an element of contingency or uncertainty into the course of events, and it prevents the participants’ views from qualifying as knowledge.” (chap1, p.4)

“For a function to be uniquely determined, it needs an independent variable which determines the value of dependent variable. In the cognitive function the actual state of affairs is supposed to be the independent variable, and the participants’ views the dependent one; in the manipulative function it is the other way round. In reflexive situations each function deprives the other of the independent variable which it would need to produce determinate results.” (p.5)

This two-way interference is called reflexivity, which is “characterized by a lack of correspondence between the participants’ views and the actual state of affairs.” (p.5)

1.2.4  How reflexivity is observed in markets

“People buy and sell stocks in anticipation of future stock prices, but those prices are contingent on the investors’ expectations. The expectations cannot qualify as knowledge. In the absence of knowledge, participants must introduce an element of judgment or bias into their decision making. As a result, outcomes are liable to diverge from expectations.” (p.5) Why in most cases, expectations of investors cannot be qualified as knowledge?

“Knowledge is represented by true statements. A statement is true if and only if it corresponds to facts. That is what the correspondence theory of truth tells us. To establish correspondence the facts and the statements which refer to them must be independent of each other. It is this requirement that cannot be fulfilled when we are part of the world we seek to understand. That is why participants cannot base their decisions on knowledge. ” (p.8) How reflexivity creates a “positive-feedback-bias”?

If the feedbacks were sequential, it would produce a uniquely determined sequence leading from facts to perceptions to new facts and then new perceptions, and so on. It is the fact that the two processes occur simultaneously that creates an indeterminancy in both the participants’ perceptions and the actual course of events.” (p.10)

That is to say, since an observant is necessarily a participant in a given human institution, the statement he made can never correspond to the “fact” he observed. The statement cannot be a knowledge since it cannot reflect the truth; as a participant, he creates new facts that cannot be truly reflected by the statements he just made as an observant. This means the decision making process of a participant cannot be “fully-rational” but bound to be biased. This is how the “positive-feedback-bias” works.

Of course, as Soros remarked, not all social situations are reflexive. But we can easily find many cases to support the proposed hypothesis in financial markets.