What is Performativity in Economics?

The theory of performativity suggests that financial or economic models instead of objectively assessing the reality of a certain aspect 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 simply define what the universe is, but is able to affect the world around it and, in doing so, help make the economic system and the actors within it — appear more similar to the theories themselves.

Understanding Performativity

Performativity is a broad term used to describe the social phenomenon that occurs when an utterance, inscription model or other form of expression. is able to affect 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 differentiate expressions that perform a task and those that reflect on the current state of affairs. 1


They are the words that affect or change the way in which the world operates. For instance, “I now pronounce you man and wife” said by anordained priest changes “bride” or “groom” in “husband” as well as “wife,” not only symbolically, but also in social actual. The social reality of the ceremony is evident by the acceptance of religious and cultural norms 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 something like the efficiency of markets or the way to price an asset is released to the market it is able to alter the structures of those models to allow the market to begin to follow the model rather than it merely portraying the market. Economic socioologist Donald MacKenzie proposes three manners of economic performance. He names the most powerful and intriguing kind “Barnesian” (after Barry Barnes, a socioologist and technologist Barry Barnes). 2. 2. In Barnesian performance “the application of the economics aspect creates economic processes that are more similar to the ones portrayed in economics.”

This notion is contrary to the theories scientists working in the natural sciences develop. The formulas used in Newtonian physics doesn’t have any significant effect on the nature of gravity’s effects on huge bodies and neither does the extensive application of thermodynamic laws alter any measurement of the rate of entropy. Economics (as as well as various social sciences) differs in the sense the sense that what it “measures” is not existent beyond the social realm–there’s no economic system to study when there is no one making or consuming, borrowing or investing.


Evidence of Performance

A well-studied case the concept of economic models that has become operational can be seen in that of the black-scholes-merton (BSM) model for pricing options contracts which streamlined the derivatives market in Chicago when it was first introduced by traders during the 1970s as well as the the 1980s.

With this particular equation, which was calculated by computers and engraved on the basis of “theoretical” rates on paper as well as terminals, option traders were transformed from carrying out what was essentially an educated guesswork in pricing and trading options to 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 price “revealed” through the mathematical model. According to MacKenzie states, “financial economics…did more than examine markets; it changed their structure.” This suggests that economic and financial models can influence market structure at the structure level.


Other instances of performance have 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 broadcasters to phone companies) to make them appear as intelligent and productive the Walrasian auctions.


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 however, there are several examples. One of them is the widespread usage of modern portfolio theory (MPT) among the passive index investing strategies. MPT employs a mean-variance optimization method to determine an optimal ” efficient” portfolio for investors and maximize their expected return , based on the level of risk tolerance. This results in an investment portfolio that has the best amount of asset class weights.

This model is based on the assumption 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 categories of asset (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 simply purchases the index-based mutual fund or exchange-traded funds (ETF) representing those assets at the market value. In the scenario where allin the market is following the guidelines of MPT then no one is left to decide on the prices of the components of these indexes, and the market becomes 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 that are based on emotional and cognitive mistakes and biases. These psychological flaws can be found in loss aversion, inconsistent preferences anchoring, the effect of endowment, among many other things.

The recognition of these errors and the application of corrective nudges based on the research of behavioral economics can help individuals make better decisions and attain more rational results. The widespread application of behavioral economics to influence or discipline people can make people 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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