Economic theory succeeded in derivatives markets partly by making markets conform to it

Evidence

This analysis of the history of the Chicago Board Options Exchange explores the performativity of economics, a theme in economic sociology recently developed by Callon. Economics was crucial to the creation of financial derivatives exchanges: it helped remedy the drastic loss of legitimacy suffered by derivatives in the first half of the 20th century. Option pricing theory—a “crown jewel” of neoclassical economics—succeeded empirically not because it discovered preexisting price patterns but because markets changed in ways that made its assumptions more accurate and because the theory was used in arbitrage. The performativity of economics, however, has limits, and an emphasis on it needs to be combined with classic themes in economic sociology, such as Granovetterian embedding and the way in which exchanges can be cultures and moral communities in which collective action problems can be solved. — Donald MacKenzie & Yuval Millo, Constructing a Market, Performing Theory, 9

Categorization

• DEFINE: Succinctly defines the paper’s core thesis of performativity against the rival view that theory merely describes preexisting patterns.
• DEEPTHINKING: The claim that option pricing theory worked not by discovery but by reshaping markets so assumptions held, plus the ‘limits of performativity’ caveat, is a genuinely paradigm-shifting framing of how theory relates to its object.
• XREF: connects to: Credit-risk regulation imports market-finance models developed for traded securities. — Ève Chiapello, Financialisation of Valuation, 60; Economic theory and actual market practice cannot be radically separated in derivatives — Donald MacKenzie, An Engine, Not a Camera: How Financial…, 1182; Option theory infrastructure allows derivatives markets to exist at current scale — Donald MacKenzie, An Engine, Not a Camera: How Financial…, 1138 (+19 more)

Related

• Option pricing theory did not describe markets but remade them in its own image (similarity 0.92)
• Economic theory and actual market practice cannot be radically separated in derivatives (similarity 0.90)
• Option theory infrastructure allows derivatives markets to exist at current scale (similarity 0.90)
• Economic theory, not trader demand, forged the proposal for the stock-options exchange (similarity 0.89)
• Economic theory helped restore legitimacy to banned financial derivatives (similarity 0.88)
• Efficient-markets theory helped legitimate options trading that regulators had long banned (similarity 0.87)
• Academic theory directly motivated the creation of the organized options exchange (similarity 0.87)
• Economists’ endorsement legitimated derivatives markets that regulators viewed as gambling (similarity 0.86)
• Option pricing theory serves as the test case for performativity. (similarity 0.86)
• The Black-Scholes methodology reshaped economists’ and regulators’ thinking beyond derivatives. (similarity 0.86)
• Option pricing converged on economic models through traders copying other users. (similarity 0.85)
• The market changed to fit Black-Scholes rather than the reverse (similarity 0.85)
• Black-Scholes-Merton theory shaped exchange fortunes before markets changed to match it. (similarity 0.84)
• Market conditions moved toward the model’s assumptions partly because of the model itself (similarity 0.84)
• Markets can be performatively constructed by agents who are not atomistic homo economicus (similarity 0.84)

Broader Connections

• Option pricing theory did not describe markets but remade them in its own image #corroborates (0.95) — Donald MacKenzie & Yuval Millo, Constructing a Market, Performing Theory, 182
• Economic theory and actual market practice cannot be radically separated in derivatives #corroborates (0.90) — Donald MacKenzie, An Engine, Not a Camera, 1182
• Economic theory, not trader demand, forged the proposal for the stock-options exchange #exemplifies (0.85) — Donald MacKenzie & Yuval Millo, Constructing a Market, Performing Theory, 63
• Option theory infrastructure allows derivatives markets to exist at current scale #expands (0.75) — Donald MacKenzie, An Engine, Not a Camera, 1138
• Economists’ endorsement legitimated derivatives markets that regulators viewed as gambling #expands (0.70) — Donald MacKenzie, An Engine, Not a Camera, 1135