Workbook for Volume 1 - Part IV: Section #18: Foundational Papers from the 20th Century, Post-World War II (1 of 15) – Von Neumann & Morgenstern
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For returning readers and subscribers: This post introduces a Revised Version for Volume 1 - Part IV: Section #18: Foundational Papers from the 20th Century, Post-World War II (1 of 15) – Von Neumann & Morgenstern
Summary:
Volume 1 - Part IV: Section #18: Foundational Papers from the 20th Century, Post-World War II (1 of 15) – Von Neumann & Morgenstern - The 2014 book edited by E. Roy Weintraub, and titled “MIT and the Transformation of American Economics” shows how the period around WWII marked a mathematical transition for Economics & Financial Economics. The second-half of the 20th century started with the formalization of “Mathematics as a Language” to define the structure of economic problems. However, as seen earlier with Hypothesis Testing, “Small Worlds” formalizations rest on “Axioms, Assumptions & Hypotheses” that created a large catalog of empirical “Puzzles, Paradoxes, & Anomalies” when applied to the “Large World”. This combination of “Axioms, Assumptions & Hypotheses” highlights the difference between theoretical “Rational Utility Maximization” and empirical “Ecological Rationality”. Real-life departures from these axioms of “Rational” choice came to be viewed by theoretical “Disinterested Observers” of the Heuristics & Bias Program as psychological “Biases & Errors” on the part of empirical “Decision Makers”. However, at the beginning of the 21st Century, Ergodicity Economics (EE) presented a practical framework that transcends this perspective by focusing on the circumstances of decision-making (“Growth Dynamics”) instead of the character and pyschological preferences of the “Decision-Maker”. The “Large World”exists independently of us, and does not care about our feelings. The formalization of such Growth optimal risk preferences started in 2020 with a paper by Yonatan Berman & Mark Kirstein, “Risk Preferences in Time Lotteries.” This work shows that “Expected Discounted Utility” (EDU) is inferior to “Growth Optimality” as a decision-making criterion for choices facing uncertainty in the timing of rewards. The paper also shows that in addition to appeals to the psychology of traits & dispositions, classical models of utility invoke risks that are not part of the decision problem specification, such as the risk that a promised payment will not arrive. This means that EE’s better explanatory power also hews to the bounds of the decision problem specifications. Why did it take Financial Economics more than 50 years to move Financial Economics beyond the 20th Century’s combination of amputating “Axioms, Assumptions & Hypotheses” with “Deus ex machina” explanations?
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”CTRI by Francois Gadenne” writes a business book in three volumes, published serially on Substack for public peer-review. The book connects the dots of life-enhancing practices for the next generation, free of controlling algorithms, based on the lifetime experience of a retirement age entrepreneur, & continuously updated with insights from reading Wealth, Health, & Statistics research papers on behalf of large companies as the co-founder of CTRI.