Eric Barthalon applies the neglected theory of psychological time and memory decay of Nobel Prize–winning economist Maurice Allais (1911–2010) to model investors' psychology in the present context of recurrent financial crises. Shaped by the behavior of the demand for money during episodes of hyperinflation, Allais's theory suggests economic agents perceive the flow of clocks' time and forget the past at a context-dependent pace: rapidly in the presence of persistent and accelerating inflation and slowly in the event of the opposite situation. Barthalon recasts Allais's work as a general theory of "expectations" under uncertainty, narrowing the gap between economic theory and investors' behavior.
Barthalon extends Allais's theory to the field of financial instability, demonstrating its relevance to nominal interest rates in a variety of empirical scenarios and the positive nonlinear feedback that exists between asset price inflation and the demand for risky assets. Reviewing the works of the leading protagonists in the expectations controversy, Barthalon exposes the limitations of adaptive and rational expectations models and, by means of the perceived risk of loss, calls attention to the speculative bubbles that lacked the positive displacement discussed in Kindleberger's model of financial crises. He ultimately extrapolates Allaisian theory into a pragmatic approach to investor behavior and the natural instability of financial markets. He concludes with the policy implications for governments and regulators. Balanced and coherent, this book will be invaluable to researchers working in macreconomics, financial economics, behavioral finance, decision theory, and the history of economic thought.
- Table of Contents
- List of Tables
- List of Figures
- Preface
- Acknowledgments
- Introduction
- Glossary of Mathematical Symbols in Order of Appearance
- Part 1. The Progressive Emergence of Expectations in Economic Theory
- 1. Expectations Before the Rational Expectations Revolution
- 2. Rational Expectations Are Endogenous to and Abide by ‘‘the’’ Model
- Part 2. Allais's Theory of "Expectations" Under Certainty
- 3. Macrofoundations of Monetary Dynamics
- 4. Microfoundations of Monetary Dynamics: The HRL Formulation of the Demand for Money
- 5. The Fundamental Equation of Monetary Dynamics
- 6. Joint Testing of the HRL Formulation of the Demand for Money and of the Fundamental Equation of Monetary Dynamics
- Part 3. Transposing the HRL Formulation to Financial Markets: Preliminary Steps
- 7. Allais’s HRL Formulation: Illustration of Its Dynamic Properties by an Example of Hyperinflation (Zimbabwe 2000-2008)
- 8. The HRL Formulation and Nominal Interest Rates
- Part 4. The HRL Formulation and Financial Instability
- 9. Perceived Returns and the Modeling of Financial Behavior
- 10. Downside Potential Under Risk: The Allais Paradox and Its Conflicting Interpretations
- 11. Downside Potential Under Uncertainty: The Perceived Risk of Loss
- 12. Conclusion
- Appendix A: How to Compute Zn and zn
- Appendix B: Nominal Interest Rates and the Perceived Rate of Nominal Growth
- Appendix C: Proofs
- Appendix D: Comparison Between the Kalman Filter and Allais's HRL Algorithm
- Appendix E: A Note on the Theory of Intertemporal Choice
- Appendix F: Allais’s Cardinal Utility Function
- Notes
- Bibliography
- Index
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