Compelled by the hard problem of asset pricing, I have abandoned equilibrium theory with rational expectations in search for a more promising land. I might have found it in systems theory with bounded rationality.

The hard problem is as follows: If demand and supply just intersect at equilibrium, why, then, does the consumption CAPM fail, but the investment CAPM succeed in the data?

In retrospect, I was trying to have the cake and eat it too. I was treating efficient markets as virtually identical as equilibrium theory with rational expectations. However, while interpreting the investment CAPM literature as defending efficient markets, I have ignored the broad failure of the consumption CAPM in the cross section.

A big thank-you to my interlocutor.

In a parallel universe, without being called out as "a bit misleading" with the investment CAPM, I would still be in my dogmatic slumber. In this universe, alerted by the hard problem, I have been foraging far and wide from my home habitat of equilibrium theory. And diverse hints are pointing me toward systems theory.


The standard theory (equilibrium) is built on the following ontological presuppositions:

• Only investors price assets (setting discount rates for firms)
• In equilibrium, sufficient to study only investors
• Who is the marginal investor? The representative investor (homogeneous expectations) as idealization
• Flat ontology: The right SDF applies everywhere (macro, micro)
• SDFism: Asset pricing is all about (nothing but) the SDF
• The risk doctrine: Only risk matters; SMB, HML as risk factors
• Rational expectations (equilibrium of beliefs, Occam's razor)

The systems theory rides on a different set of ontological presuppositions:

• The world is a system of open, adaptive systems in evolution (Simon 1962)
• Corporate actors as primary causal powers of their own asset prices
• The invisible hand as spontaneous order (bottom-up coordination) via the market process, not a set of simultaneous equations with a unique Kakutani fixed point
• Emergence from interacting, heterogeneous actors: The marginal investor not an individual investor (an ant colony not an individual ant)
• SDFism: Greedy (eliminative) reductionism (Dennett 1995)
• EMH: Unpredictable abnormal returns (ecological rationality), not equivalent to rational expectations
• Bounded rationality (Simon 1957), subjective expectations (Mises 1949)

In my presentation at EDHEC Speaker Series, I explain why after 20 years of defending equilibrium theory, I have no choice left but to leave it behind in pursuit of systems theory.

To solve the hard problem of asset pricing is my urge.

And the socialist calculation debate is my phase transition.

Please see slides and video recording below. I am very grateful to Prof. Hamid Boustanifar for the kind invitation.

We have just released the 2024 edition of testing portfolios for the q-data library. Please see:

global-q.org/testingportfolios.html

All anomaly categories except for profitability have taken a hit in 2023.

Across 48 anomaly variables, the high-minus-low profitability decile earns on average 18.57%.

The expected growth decile has done even better, earning on average 35.84%, 40.73%, and 32.69% at the 1-, 6-, 12-month horizons, respectively.