Neoclassical finance requires only a few well-financed arbitrageurs, not rational average investors.

Evidence

The absence of arbitrage requires that there be enough well financed and smart investors to close arbitrage opportunities when they appear… Neoclassical finance is a theory of sharks [arbitrageurs] and not a theory of rational homo economicus, and that is the principal distinction between finance and traditional economics. In most economic models aggregate demand depends on average demand and for that reason, traditional economic theories require the average individual to be rational. In liquid securities markets, though, profit opportunities bring about infinite discrepancies between demand and supply. Well financed arbitrageurs spot these opportunities, pile on, and by their actions they close aberrant price differentials… Rational finance has stripped the assumptions [about the behavior of investors] down to only those required to support efficient markets and the absence of arbitrage, and has worked very hard to rid the field of its sensitivity to the psychological vagaries of investors. (Ross 2001, p. 4) If, in contrast, the potential for arbitrage is constrained, then discrepancies between finance-theory models and “reality” may persist, and the effects on patterns of prices of the phenomena pointed to by behavioral finance may not be eliminated. — Donald MacKenzie, An Engine, Not a Camera, 1212

Categorization

• DEFINE: Clarifies the core distinction between neoclassical finance’s ‘shark’ model and traditional economics’ rational average individual.
• XREF: Connects to Shleifer’s behavioral finance critique and the limits-of-arbitrage literature that follows in this very chapter. — connects to: Market arbitrage requires only that investors prefer more wealth to less, not risk preferences — Donald MacKenzie, An Engine, Not a Camera: How Financial…, 180; Narrow self-interest does not necessarily yield efficient exchange. — Diego Gambetta, Trust - Making and Breaking Cooperative…, 2626; Neoliberal market advocacy does not require assuming rational self-interested actors. — Dieter Plehwe, Quinn Slobodian & Philip Mirowski (eds.), Nine Lives of Neoliberalism, 333

Broader Connections

• Market arbitrage requires only that investors prefer more wealth to less, not risk preferences #expands (0.80) — Donald MacKenzie, An Engine, Not a Camera, 180
• Neoliberal market advocacy does not require assuming rational self-interested actors. #contradicts (0.75) — Dieter Plehwe, Quinn Slobodian & Philip Mirowski (eds.), Nine Lives of Neoliberalism, 333
• Narrow self-interest does not necessarily yield efficient exchange. #corroborates (0.72) — Diego Gambetta, Trust - Making and Breaking Cooperative…, 2626