If economics can explain every financial situation, then why do we have separate specializations as finance in MBA?

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Posted by Anna Patricia (Questions: 8, Answers: 12)
Asked on September 3, 2014 4:02 pm
Category: Business School
Posted by Ria Mueda (Questions: 11, Answers: 8)
Answered On September 3, 2014 4:27 pm

Economics as a field of study is diverse, ever-changing, and extremely vast. As Marc Stern points out – you have Macro- and Micro- economics. Finance is a sub-field of economics (or at least it is typically construed that way by colleges/universities).

It seems like what you’re really asking is: why we have finance if MACRO-economics (broader market trends and activity) can explain everything. This is a cool question, and I have a few thoughts, with the caveat that this is not necessarily an area of tremendous expertise. B

1. Something akin to bounded rationality – essentially, EVEN IF macro- and (some) micro-economics can explain all financial movements, there is no way for us to process or even acquire all the necessary data we would need in order to predict or even calculate something as nominal as a stock price, options volatility, etc.

An analogy is the debate on human free will. IF, in fact, all human behavior can be predicted based on their genetic make-up, brain chemistry, personal history, present circumstances, etc., we could never gain enough data on these factors to make such predictions possible. There is simply too much moving too quickly, some of which cannot be measured.

2. Heuristic – because we cannot acquire/process sufficient data, we rely on heuristics. Finance – or at least securities trading – is a way of crafting general, easily-measurable rules intended to reflect an aggregate of complex, ever-changing variables.

For example, the bid/ask spread, P/B, etc. subsume or try to subsume tons of additional, smaller variables (like investor behavior in the case of the spread, asset valuation as well as market valuation – itself a product of market behavior – in the case of P/B).

Basically, finance is practical application. Although ”Economics” may, in theory, be able to explain every financial outcome, there is no practical way to use it. Although, from what I understand, the use of macro-trends to predict investment opportunity is one of the strongest features of Bridgewater (Ray Dalio’s firm).

Just my two cents. Hope I didn’t say something stupid.

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