By Research Affiliates. Originally published at ValueWalk.
Key Points
- Research fads, which create bubbles in academia, gobble up resources and crowd out exploration of competing ideas.
- Investment-related academic bubbles have a cost. In the best case, money is lost by investors chasing fragile ideas. In the worst case, the general public suffers real pain when the economy at large is hit directly, such as in the 2008 global financial crisis.
- Academics and practitioners alike can stop contributing to bubbles by being more skeptical and curious, and reaffirming a commitment to the scientific method in which theories are testable, verifiable, and falsifiable.
Tactical Asset Allocation And The US 60/40 Benchmark
We often talk about bubbles in financial markets. Bubbles also exist in popular ideas and in academic research. Research fads gobble up resources and crowd out exploration of competing ideas until the hot topic is exhausted. By then, the topic of the day is often stretched dangerously beyond its usefulness.1
To state the obvious, academe—an extraordinary source of ideas and insights— is no less susceptible to bubbles than is the stock market. The bubble phenom- enon is not, by any means, unique to finance theory. String theory, anyone? String theory is a brilliant hypothesis that fails the most basic test for scientific method: it’s unfalsifiable. The theory cannot be tested and therefore cannot be shown to be false.
As consumers of academic research, we should seek to take the good and leave the bad, mindfully aware we cannot easily discern one from the other. As quants, we should aim to be healthy skeptics, neither gullible nor overly cynical, hyper-alert to the risks and consequences of data mining and selection bias. We should also recognize that much of academia disregards the inconveniences of trading costs, bid–ask bounce, missed trades, implementation constraints, and other portfolio construction nuances. Finally, we should harbor no illusions that—apart from the “free lunch” of diversification—the quest for alpha is easy, inefficiencies are lasting, or great ideas will not be quickly arbitraged away.
Anatomy of an Academic Bubble
Intellectual prowess does not imbue immunity to the susceptibility of participation in bubbles. Johannes Kepler, best known today for documenting the mathematics of planetary motions, was far prouder of his skills as an astrologer. In addition to inventing calculus and discovering gravity, Isaac Newton was equally passionate about alchemy. Sure enough, astrology and alchemy were contagious ideas of their eras, and those eras’ greatest minds went along for the ride.
Academic bubbles arise for precisely the same reason that bubbles arise in financial markets—human nature. An academic bubble typically starts with a truly significant and timely research insight. The researcher behind the groundbreaking insight receives well-deserved professional accolades, lasting credit, and splendid career growth. Soon enough, the halls of academe bustle with a growing roster of professors and post-docs pursuing similar research, likely out of genuine interest in the new insight. Students are encouraged, explicitly or not, to embrace the new approach. Those who go into the so-called real world follow the precepts they were taught. Within academe, newly minted PhDs seeking tenure often align their work with more senior colleagues. Very quickly, a dominant set of questions takes precedence, and other work is de-emphasized, even shunned.2 In the extreme, ideas that do not align with the dominant body of knowledge are labeled heretical, some- times explicitly, and dismissed altogether.
A good example of this phenomenon is the current ubiquitous reliance on neo-Keynesianism in the macroeconomics profession. Is it surprising that a field of economics that applauds the role of government in the macroeconomy garners generous government funding, while competing views do not? We surmise that Keynes himself would be hard-pressed to earn tenure in today’s academic community given his reluctance to rely on permanent deficits, preferring to run surpluses in good times, which can fund deficits in bad times, borrowing as needed if a recession is deep enough.
Eventually, sometimes with painful delay, one-time heresies are eventually accepted within both economics and the so-called hard sciences.3 Among these, we count continental drift; origin of species; heliocentric solar system and Newtonian physics; expanding universe (and now, accelerating universe); atoms and quarks; quantum physics, loathed by none other than Einstein himself; impact theory of mass extinctions; behavioral finance; and in the medical field, hand washing to avoid the spread of illness. All of these theories were viewed as heretical at the outset, and all are now received wisdom.
The theory of continental drift, for example, was put forth by a series of scientists beginning in the late 1500s through the mid-1800s. Alfred Wegener made the first modern attempt at formalizing the concept in the 1910s. The idea was rejected as recently as the 1950s, just years before the theory of plate tectonics forced earth scientists to accept the concept that once and for all (Oskin, 2015). Similarly, Darwin’s The Origin of Species, published in 1859, was greeted with skepticism and derision, if not downright hostility. Decades after its introduction, Darwin’s theory of evolution still faced significant challenges. Even today, it remains controversial in certain groups outside the scientific community (Boffey, 1982).
Hand washing, with self-evident merit today, faced unbridled doubt and incredulity when first suggested to the medical community (Davis, 2015). In the mid-1800s, Hungarian doctor Ignaz Semmelweis worked in the maternity clinic at the General Hospital in Vienna. Seeking to reduce the number of women dying from childbed fever, he studied two maternity wards, one staffed by male doctors and the other by female midwives. He observed that women were dying at a rate five times greater at the male-staffed clinic than at the female-staffed clinic. After ruling out (by experimentation) a few differences in treatment, Semmelweis, in frustration, took time off to travel to Venice.
Upon his return, Semmelweis learned of a pathologist who had taken ill and died after conducting an autopsy (a common practice in medicine at the time) on a patient with childbed fever. During the autopsy, the pathologist pricked his finger. Semmelweis knew childbed fever was being spread at the hospital. He knew that male doctors—but not midwives—conducted autopsies between deliveries and surmised that particles from the autopsies were traveling on the doctors’ hands, making the next patient ill. Semmelweis introduced chlorine for doctors to wash their hands with after autopsies and before deliveries. Sure enough, the rate of childbed fever deaths fell sharply. Remarkably, the doctors rejected the idea, because it meant they were to blame for the hospital deaths. The doctors at the maternity clinic eventually rebelled, and Semmelweis was fired!
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