04/05/06

Was studying in the evening

I was reviewing the famous Modigliani and Miller theory,

which claims (in their first model) the change in the capital structure does not affect the market value of the company at all.

Which is totally crap.

 Having admitted that their first model was totally crap,

they published a second model some years later,

this time, realising that there is taxation in most of the civilised countries.

So now they claim, that the market value of the company increases the more the company increase its debt.

Which is again so crap.

Economic model (or finance model in this case), in order to have some meaning, must generalise and simplify the world we live in.

They often introduce so many 'assumptions' that it only makes sense in a mathematical model,

but far from the truth in what's happening in the real world.

So came the so-called 'behavioral economists', who focus on a realistic behaviour of human-being and try to make a model out of it.

For example, they realised that even if the number of woman in the labour force increases,

the birth rate of a country does not decrease, in fact it increases, because woman merely cuts her time to do their housework or let man to do it.

Interesting I thought, Japan can double its GDP if they let more woman to take part in the labour force.

Behavioural economics is the future of economics.


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