Financial theories can become true by guiding the practices they describe

Evidence

Financial economics developed a set of sophisticated mathematical tools for valuing financial assets, from discounted cash flow analysis to the capital asset pricing model to the Black-Scholes options pricing model. New tools allowed markets to develop for new kinds of financial instruments. Performativity—the idea that theories guide practices in a way that leads them to become true—is a recurring theme in finance (Callon 1998, MacKenzie et al. 2007). MacKenzie & Millo (2003) document how the Black-Scholes option pricing model shifted from being a clearly inaccurate description of pricing to a guide for trading that thereby became true. — Gerald F. Davis & Suntae Kim, Financialization of the Economy, 38

Categorization

• DEFINE: Clear definition of performativity in finance with the Black-Scholes example as the canonical case.
• XREF: Connects to the broader performativity-of-economics literature (Callon, MacKenzie) familiar from sociology of markets work. — connects to: Economic theory is commonly assumed to map perfectly onto a constant reality — Mark Blyth, Austerity: The History of a Dangerous…, 119; Economic theories are endogenous and actively shape the world they describe. — Mark Blyth, Austerity: The History of a Dangerous…, 122; Finance theory shapes markets through the linguistic infrastructure it provides practitioners — Donald MacKenzie, An Engine, Not a Camera: How Financial…, 1128 (+8 more)

Related

• Financial models construct the markets they purport only to describe. (similarity 0.88)
• Financial pricing formulas actively construct the markets they purport to measure (similarity 0.87)
• Performativity claims must be distinguished from the market merely converging on a correct theory. (similarity 0.87)
• The discovery-then-acceptance narrative misdescribes how financial economics shaped markets (similarity 0.86)
• The market changed to fit Black-Scholes rather than the reverse (similarity 0.85)
• Market conditions moved toward the model’s assumptions partly because of the model itself (similarity 0.84)
• Financial instruments shape markets rather than merely read them (similarity 0.84)
• Finance theory altered its own empirical object of study (similarity 0.84)
• Finance theory often shapes managers’ vocabulary without changing their actual practice (similarity 0.84)
• Financial economics actively alters markets rather than merely describing them (similarity 0.83)
• Performativity and efficiency both potentially explain the formula’s growing accuracy. (similarity 0.83)
• Option theory infrastructure allows derivatives markets to exist at current scale (similarity 0.83)
• Finance theory’s core models assume frictionless markets with no transaction costs or short-selling penalties (similarity 0.83)
• Finance theory shapes markets through the linguistic infrastructure it provides practitioners (similarity 0.83)
• Black-Scholes-Merton theory shaped exchange fortunes before markets changed to match it. (similarity 0.83)

Broader Connections

• A financial model can be written into regulation to enact its own assumptions #exemplifies (0.95) — Donald MacKenzie, An Engine, Not a Camera, 742
• Finance theory shapes markets through the linguistic infrastructure it provides practitioners #corroborates (0.90) — Donald MacKenzie, An Engine, Not a Camera, 1128
• Finance theory often shapes managers’ vocabulary without changing their actual practice #complicates (0.85) — Donald MacKenzie, An Engine, Not a Camera, 1136
• Finance theory altered its own empirical object of study #corroborates (0.85) — Donald MacKenzie, An Engine, Not a Camera, 388