Performativity

What is the definition of performance in economics?

The theory of performativity suggests that models of finance or economics are not merely measuring an aspect of reality but instead, assist in shaping this aspect of reality into what the model portrays. In other words, it is the idea that economic theory doesn’t just define what the universe is, but is able to influence the world and create the economic system and the actors within it — appear more similar to the theory it describes.

Understanding Performativity

Performativity is a broad term used to describe the social mechanism by which an utterance, inscription model or other form of expression. is able to impact the world it is attempting to describe. The philosopher of linguistics J. L. Austin invented the concept as a reference to an “performative speech” to distinguish words which perform something and those that reflect on the current state of affairs. 1

 

The words that affect or change the current state of the world. For instance, “I now pronounce you man and wife” said by anordained priest changes “bride” or “groom” to “husband” as well as “wife,” not only symbolically, but also in real. This social reality manifests in the recognition of religion and culture and treatment under the law as well as changes to household finances and taxation to mention the most prominent.

If an economic model that explains such things as the efficiency of markets or the way to price an asset is released to the market it is able to modify the structure in order for the market to adjust to follow the model, instead of it merely portraying the market. Sociologist and economist Donald MacKenzie proposes three manners of economic performance. MacKenzie calls the strongest and most intriguing kind “Barnesian” (after Barry Barnes, a scientist and sociologist Barry Barnes). 2. 2. In Barnesian performance “the application of the economics aspect creates economic processes that are more similar to the way they are described through economics.”

This is in stark contrast to the theories that scientists working in the field of natural science develop. The formulas used in Newtonian physics doesn’t significantly alter the nature of gravity’s effects on huge bodies or the wide-spread application of thermodynamic laws affect any real-world measurement of the entropy. Economics (as as well as various social sciences) differs in the sense that the thing it “measures” isn’t existent beyond the social realm–there’s no economic system to study without a person making consumption, borrowing, or investing.

 

Evidence of Performance

A well-studied case the concept of economic models turning useful can be seen in that of the black-scholes-merton (BSM) model for pricing options contracts that streamlined the derivatives market in Chicago when it was first introduced for trading in the 70s and the 1980s.

Based on this specific equation, which was calculated by computers and engraved with “theoretical” rates on sheets of paper as well as terminals, option traders were able to transform out what was essentially an educated guesswork in trading and pricing options into the calculative arbitrageurs purchasing options contracts that were too cheap and selling them when they were priced at a premium. The market itself for options grew to consistently meet the costs “revealed” through the mathematical model. According to MacKenzie claims, “financial economics…did more than analyse markets, it also altered the way they functioned.” This implies that models of economics and finance are able to alter market structure at the structure level.

 

Another example of performativity has been discovered in the creation of market auctions (e.g. through FCC to auction bandwidth rights from TV stations FCC to auction bandwidth rights from television channels to cell phone operators) to make them appear as sensible and effective and rational auctions.

Counterperformativity

Though performativity argues that the pervasive use of an economic model can influence the world to appear more like the theory itself over time, the opposite concept of counterperformativity argues that the use of a model instead makes the world appear less like the theory would predict.

 

Although this might seem contradictory There are a variety of examples. One of them is the widespread usage of modern portfolio theory (MPT) among the passive index investing strategies. MPT utilizes a mean-variance-optimization method to determine an optimal ” efficient” portfolio for investors and maximize the expected return based on the level of risk tolerance. This results in an optimal portfolio with the right amount of asset class weights.

The model supposes that markets function efficiently and, consequently doesn’t consider the price of assets Instead, it tells you how much of your portfolio needs to be invested in what types of assets (e.g. 40% of domestic stocks 25 percent foreign stocks and corporate bonds, with 25 and 10 percent Treasuries). A person who is an index investor following MPT will simply buy the index-based mutual fund or exchange-traded funds (ETF) representing those asset classes at a market prices. In the scenario where allin the market is following the guidelines of MPT there is no one left to determine the price of the constituents of these indexes, and markets are inefficient because of a lack of price information.

 

A second example of counterperformativity is the use of behavioral economics to “nudge” people to make more rational influence behavior to make for optimal outcomes. According to the theories of behavior economics humans are not rational, but are prone to making a variety of mistakes due to emotional and cognitive mistakes and biases. These mental flaws are characterized by loss aversion and time-inconsistent preference anchoring, and the effect of endowment, among many other things.

The recognition of these errors and the application of corrective nudges guided by the findings of behavioral economics can help individuals make better decisions and to achieve more rational results. The widespread usage of behavioral economics as a method to discipline or nudge people causes people to appear less like what the models of behavioral economics (and instead , more like the mainstream economic models that suppose that rational actors can predict).

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