Understanding Finance Through Convention Theory

Abstract

The use of conventions in finance stems from the uncertainty about the future state of the economy, companies, states, and markets. Under these conditions, economic theory would require everyone to resort to subjective probabilities and idiosyncratic anticipations. The presence of this uncertainty could discourage any market commitment. However, the observation of financial reality contradicts this theoretical vision of individuals calculating in isolation and the theoretical absence of trade in this informational context. This is because actors in financial markets mobilize conventions to escape individual uncertainty. Nothing in the financial markets is “natural”; therefore, the framework proposed by the economics and sociology of conventions (EC/SC) is particularly well adapted to reveal it and understand it.

The main result of EC/SC or convention theory is to base the equilibrium price on collective constructions linked to individual and social interactions. It is possible to distinguish financial convention stemming from the theoretical Keynesian tradition to those more empirical with which aims to identify the social constructions. The first current has made it possible to theorize the origin of financial instability as the alternation of shared bullish and bearish beliefs. The second gives empirical legitimacy to the financial conventions: conventions devoted to evaluation and conventions for coordination. The mobilization of these two approaches allows a complete understanding of financial regulation: observation allows us to understand the origin of a convention, and modelling with the use of mimicry allows us to understand price dynamics.