Most subjects of human enquiry are supported by a generally acknowledged and respected theoretical framework which explains how things work and why they sometimes fail. The field of finance is poorly served in this regard, supported only by an academic theory that predicts the perfection of “efficient markets” while ignoring market imperfections.

As a result, investors and practitioners are left to fend for themselves drawing on convention, past experience and a theory they don’t believe in to inform their actions. It is hardly surprising that the finance industry is failing society with its periodic crashes, vast cost and unaccountability.

The theory developed at The Paul Woolley Centre, supported by empirical studies, represents a radically new approach that takes into account the principal-agent problems arising when asset owners delegate responsibility to asset managers. It shows that asset mispricing can occur despite all market participants acting prudently to maximize profits in light of the available information.

The new framework offers fuller and more convincing explanations for the principal forms of asset mispricing than have so far been presented in the academic or practitioner field. The implications extend to all market participants; both for private strategies and for the social ends of better functioning markets.

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Giant funds must curb short-termism

Many of the problems of present-day finance have their origins in the horizons set along the investment chain. The key players in this chain are the giant pension, sovereign wealth and endowment funds who appoint external asset managers, who in turn invest in companies. If these funds invest with their eyes set partially or largely on the short term, it sends a clear message down the line and embeds similar standards throughout the capitalist system.

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Markets as amplifiers of crises

The finance sector is widely recognised as an originator of periodic crises. What is less widely discussed is the unhelpful role that the finance sector can play in amplifying crises that emerge from entirely non-financial origins.

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