Allais Maurice - Uncertainty, expectations, and financial instability : reviving Allaiss lost theory of psychological time

Uncertainty, Expectations, and Financial Instability

Uncertainty,

Expectations,

and

Financial

Instability

REVIVING ALLAISS LOST THEORY OF PSYCHOLOGICAL TIME

Eric Barthalon

Columbia University Press New York

Columbia University Press

Publishers Since 1893

New York Chichester, West Sussex,

cup.columbia.edu

Copyright 2014 Columbia University Press

All rights reserved

E-ISBN 978-0-231-53830-5

Library of Congress Cataloging-in-Publication Data

ISBN: 978-0-231-16628-7 (cloth)

ISBN: 978-0-231-53830-5 (ebook)

Library of Congress Control Number: 2014936226

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COVER DESIGN:

Noah Arlow

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To Rozenn

Contents

That a book having the ambition to build bridges between Allaiss theory of psychological time and behavioral financea book furthermore containing many mathematical developments, numbers, and figurescould start with words borrowed from R. L. Stevenson and D. H. Lawrence, should surprise more than a few readers. Yet, the reason for this choice is very simple: these two authors brilliantly express the motivations that, besides the wish to explain Allais to myself, have led me to write this book.

Stevenson, first. By tracing any revival of letters back to the discovery or rediscovery of earlier and fresher models, Stevenson shows a path toward progress that is valid for any intellectual discipline, economics included. The conviction I neither would nor could conceal is that Allais is a gigantic economist, a true genius, a genuine artist, from whom we still have a lot to learn. This is true now more than ever, since mainstream economic theory seems at a loss to explain the economic and financial crisis that seemingly started in 2007, but which had been in the making for many years.

Then, Lawrence. It is an understatement to say that Allais paid lip service to the marketing of his works: his passion for research has overwhelmed him time and again. People who knew him well politely describe him as not easy to work with. Were the Nobel Foundation to award a prize for self-promotion, Allais would never make it to the short list of potential laureates. May this book prompt researchers to overcome the hurdles, some of them inadvertently erected by Allais himself, behind which lie, still to be recognized and appreciated, many theoretical jewels!

Last but not the least, there is no reason to pit mathematics against letters. Mathematics is nothing but a language that aims at combining conciseness with the utmost lack of ambiguity, two seemingly contradictory requirements. Literature is replete with references, most of the time implicit, to psychological time, the cornerstone of Allaiss theory of expectations under uncertainty. Economics does need philosophers, novelists, and poets to reveal essential aspects of human psychology. Guided by their intuition and experience, poets, novelists, and philosophers tend at least to hint at many of the most essential characteristics of human nature and psychology. But economics also needs mathematicians and physicists to rigorously answer the questions raised by people of letters. This is, I believe, what Allais has achieved with his theory of psychological time and memory decay.

SOME THIRTY years ago, someone inadvertently triggered the chain of events that has led to this book. Robert Carvallo was his name. Inclined to tolerate trials and errors with benevolence, he has been much more than my first boss. He has been a patient teacher. He had seen me struggling with one of the first HP 12C circulating in Paris as I was trying to calculate the present value of the cash flows expected from an office building that Paribas had bought in downtown Manhattan. This made me apt, according to him, to manage bond portfolios. Without this fresh assignment, I would not have been confronted, early in my professional life, with the issue of expectations formation. I vividly remember how I was wondering in 1983, child of the inflation age that I was, whether it was a good idea to lend money to the French Republic for 7 years at 13.70 percent. Had someone told me then that 22 years later, France would issue a 50-year bond bearing a 4 percent coupon, or that 30 years later we would see negative nominal interest rates on short-dated government bonds, I would have questioned his or her sanity. No wonder that Robert Carvallo used to tell me that nothing is more important in economics and finance than seeking to understand how expectations are formed! To Robert Carvallos name, I want to associate those of Jean-Paul Villain, who opened Paribass doors a second time for me in 1992, and of Andr Lvy-Lang, Dominique Hoenn, and Philippe Dulac. Their decision to appoint me Chief Economist of the Paribas Group in 1996 was bold indeed, since I did not possess any of the usual academic passports one would expect the chief economist of an international banking group to hold. Despite my interest in expectations, I certainly did not expect them to entrust me with such a responsibility. To honor their trust as well as that of the Paribas staff became a duty, which pushed me to broaden and deepen my autodidacts education.