The normative foundation of finance: How misunderstanding the role of financial models distorts the way we think about the responsibility of financial economists

Abstract

The financial crisis has fueled a heated debate about the responsibility of financialeconomists. Critics such as Paul Krugman, Robert Shiller, and David Colander arguethat financial economists have developed useless or even harmful theories. This isan important debate, but it suffers from the fact that the role of financial theoriesremains unclear. In this chapter we enter the field of philosophy of science to clarifythis issue. In particular, we emphasize the research interests and the various philosophicalassumptions of three alternative views on financial theories. We analyzethe widespread positivistic conception of financial theories and contrast it with apostmodern perspective. We conclude that both positions have limitations. As analternative, we outline a constructivist conception of financial theories. In the finalsection, we use these insights from philosophy of science to clarify the responsibilityof financial economists. Financial economists have to critically reflect the problemsin practice that need to be addressed and to keep their theories closely tied to theseoriginal problems. We show how, in the case of the efficient market hypothesis, themisunderstanding of the role of financial theories led financial economists to neglectthis responsibility.