There is nothing wiser than betting on the madness of men

(Published by JP Bouchaud | November 2024)

Il n'y a rien de plus sage que de miser sur la folie des hommes

(There is nothing wiser than betting on the madness of people)

A chilling quote from G. da Empoli’s great novel “Le mage du Kremlin”, which applies universally and across all periods, sadly even more these days it seems.

So why did economists take the exact opposite stance and postulated that humans act rationally? I have heard two answers to this question.

One is that when it comes to money, or to their economic interest, people are overall rational.

Oh really? Isaac Newton famously said that he could calculate the motion of planets, not the madness of people. Indeed, even professional investors are stricken with all sorts of behavioural biases: overconfidence, panic, herding.. Economic agents often seem to find more solace in narratives of all kinds (religious, nationalistic, etc.) than in their savings accounts.

The second is that such a framework allows one to prove mathematically rigorous theorems and avoid the jungle of bounded rationality and shoddy statements, giving to economics the status of a “true” hard science. (As if physicists had built their field on theorems).

This has led to a slew of famous “theorems” that are ludicrously far from reality: the "fundamental" welfare theorems, the "fundamental" theorem of asset pricing, the “no-trade” theorem (if people were rational, they should not trade at all!), the Modigliani-Miller theorem, etc.

Mathematics is about proving theorems (make no mistake, I am in awe of mathematicians). Good science is about getting the assumptions right.