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Market Uncertainty, Information Complexity, and Feasible Regulation: An Outside View of Inside Study of Financial Market

Abstract:The view from inside improves our understanding on market failure and regulation failure in financial market. The EMH fails to understand the causes of financial bubbles and crashes. Behavioral finance introduces insight from psychology. The heuristic and biases (H&B) approach studied behavioral asymmetry in static environment that leads to market irrationality and information distortion. The fast and frugal (F&F) thinking in decision-making further explore more complex situation under changing environment. They argue that soft-paternalistic regulation is needed under information overload. The most critical issue is information uncertainty and complexity. Lacking information in frequency domain is the main barrier in managing business cycles. Data form inside reveals current limitations of financial data mainly in the short-term price changes. Microstructure studies show that pricing process is shaped by trading rules. Quantitative analysis reveals severe instability in high frequency trading (HFT) and derivative market. Feasible regulation should aim to encourage new technology and sustainable growth, rather than protect obsolete technology and short-term speculation. The most fundamental challenge to sustainable economic order is the excessive size of the derivative markets that crowding out investment in real economy. This is a more severe issue than the climate change.

 Key Words: market uncertainty, information complexity, feasible regulation, financial crisis, regime switch.

Market Uncertainty, Information Complexity, and Feasible Regulation: An Outside View of Inside Study of Financial Market

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