Tuesday, 10 June 2008

Supply and demand

One of the other books I bought recently was The New Paradigm for Financial Markets by George Soros. I've always quite liked what I have read of his stuff, and his conception of reflexivity is an interesting one.

Anyway I just finished a good bit in the new book where he gets stuck into the idea of equilibrium in markets. There's a taster below, apologies for any typos.

The shape of supply and demand curves cannot be taken as independently given because both of them incorporate the participants' expectations about events that are shaped by their own expectations. Nowhere is the role of expectations more clearly visible than in financial markets. Buy and sell decisions are based on expectations about future prices, and future prices, in turn, are contingent on future buy and sell decisions.

...Anyone who trades in financial markets where prices are continuously changing knows that participants are very much influenced by market developments. Rising proces often attract buyers and vice versa. How could self-reinforcing trends persist if supply and demand were independent of market prices? Yet, even a cursory look at commodity, stock and currency markets confirms that such trends are the rule rather than the exception.

The very idea that events in the marketplace may affect the shape of the demand and supply curves seems incongruous to those who have been reared on classical economics. The demand and supply curves are supposed to determine the market price. If they were themselves subject to market influences, prices would cease to be independently determined. Instead of equilibrium we would be faced with fluctuating prices. This would be a devastating state of affairs. All the conclusions of economic theory would lose their relevance to the real world...


Nick Drew said...

which is why price forecasting is a sorry joke - horoscopy with numbers, as they say

mean reversion is worth analysing, though

Tom P said...

Mean reversion in what context?

Nick Drew said...

sorry, it's a random technical comment

for reasons including the ones Soros cites, short- and even medium-term price movements can be all over the place, and fundamentals are a VERY poor guide to understanding them, all the way to useless sometimes (although dyed-in-the-wool fundamentalists are always good at 'explaining' them after the event ...)

but mean reversion often shines through on historical analysis, and there's (almost) no disputing it 'cos it's purely a statistical diagnosis

& then you have got something real to get your teeth into

Tom P said...

I get you. Actually he has a bit of a pop about mean reversion at some point too, can't remember exactly what he says.

Having almost finished the book, it is clear that it is mainly (another) pitch for his conception of reflexivity to be taken seriously. I actually like the idea, though I think it has some gaps in it, but it doesn't make for a great book on the current crisis.