Uneconomic Economics and the Crisis of the Model World by Matthew Watson (auth.)

By Matthew Watson (auth.)

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Mortgages were issued in the increasing absence of reasonable due diligence tests (House of Commons Treasury Committee 2008: 166; Financial Services Authority 2009: 45) because it was mortgage volume and not the intrinsic viability of individual mortgage repayment schedules that mattered most to the ability to create mortgage-backed securities. Without those securities the corresponding CDO market that Li’s model depicted as a potential trading goldmine would have been unimaginable. The move to mass mortgage issues helped to keep house price increases bowling along, which at the same time seemed to confirm the robustness of Li’s model, as it would work for as long as the immediate future shadowed the recent past by avoiding a housing market downturn (Muolo and Padilla 2008: 171).

Keywords: collateralised debt obligations; Gaussian copula formula; Kuhnian exemplar; mortgage-backed securities; probabilistic risk models; Schumpeterian Vision Watson, Matthew. Uneconomic Economics and the Crisis of the Model World. Basingstoke: Palgrave Macmillan, 2014. 0005. 0005 The Collapse of the Model World  Introduction Macroeconomic models of dynamic stochastic general equilibrium (DSGE) and financial models exhibiting the efficient markets hypothesis (EMH) are generally treated as distinct entities.

A whole generation of exceptionally gifted mathematically informed theoretical economists have followed in the Arrow–Debreu tradition, and they have demonstrated the ever more exacting economic restrictions that have to be imposed if the original existence theorem is to produce stable conditions in the model. Given the continuing significance of the underlying Vision of the market world to orthodox economics opinion, some rather startling results have ensued. 0005 The Collapse of the Model World  participants to be fully rational and utility maximising in their actions, the Law of Demand cannot be shown to work for even a single ‘market’ in isolation (Sonnenschein 1973; Mantel 1974; Debreu 1974).

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