Video: The Flaws of Finance - James Montier
Also, here's a post by Thomas J. Brakke on Montier's speech.
So what are the flaws?
According to Montier, the flaws fall into four categories:
- Bad Models
- Bad Policies
- Bad Incentives
- Bad Behavior
First of all, finance isn't physics but damaging models exist that seem to assume otherwise.
Finance is a social science yet that's somehow misunderstood and/or ignored by some industry participants and their regulators. Popular models like capital asset pricing model (CAPM) and value-at-risk (VaR) mostly fail in reality even if interesting in another, more academic, context.
Once tested under real world conditions they've proved to be flawed and dangerous.
Things that seem to work until they don't.
Policy makers, at least in the past, have tended to buy into some the flawed models (created by the banks themselves no less) leading to what is a great example of regulatory capture.
There are too many poorly constructed incentives in the investment business and throughout the financial system. These incentives often reinforce the wrong behavior and play right into the cognitive biases and other errors in judgment that adversely impact investor decision-making.
Check out Montier's full speech.