Epistemic virtue and vice in mathematical finance

14/05/2014 (17h-19h) : Pr. Boudewijn de Bruin, University of Groningen.

By using recent insights on so called epistemic virtues and theory of epistemic virtue to shed light on this episode in the history of economic thought and prudential regulation, I defend the claim that rather than greed and egoism, the most pressing ethical failures that have led to the global financial crisis are failures of epistemic virtue. Banks failing to support research and development, regulation unjustifiably outsourcing judgements of creditworthiness to unreliable credit rating agencies, clients showing no interest whatsoever in the conditions of their mortgages, private investors overestimating their investment skills – these are all examples of epistemic vice.


Now we extend this approach to the use of mathematical representations in finance. There are two fundamentally different views of uncertainty in finance:

  1. One view prices movements as continuous processes, and models them with representations based on continuity. In this case, Brownian motion is the standard model and part and parcel of finance curricula across the globe. It is the point of reference of most top journals in the field; it is the dominant view in the financial industry itself; and it underlies almost all regulation worldwide, ranging from the Basel accords and Solvability II to national banking standards.
  2. The other view prices movements as discontinuous processes, and models them by representations based on discontinuity.

Using the epistemic virtue and vice approach, we argue that:

  1. the preference among economists and regulators for Brownian representation of uncertainty can be explained as at least partly resulting from a particular epistemic vice, namely, epistemic injustice
  2. and conversely, we argue that the Brownian representation itself constitutes a significant obstacle to practising epistemic virtue, in particular epistemic temperance and humility.

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