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From dissonance to resonance: cognitive interdependence in quantitative finance

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  • Beunza, Daniel
  • Stark, David
Abstract
This study explores the elusive social dimension of quantitative finance. We conducted three years of observations in the derivatives trading room of a major investment bank. We found that traders use models to translate stock prices into estimates of what their rivals think. Traders use these estimates to look out for possible errors in their own models. We found that this practice, reflexive modelling, enhances returns by turning prices into a vehicle for distributed cognition. But it also induces a dangerous form of cognitive interdependence: when enough traders overlook a key issue, their positions give misplaced reassurance to those traders that think similarly, disrupting their reflexive processes. In cases lacking diversity, dissonance thus gives way to resonance. Our analysis demonstrates how practices born in caution can lead to overconfidence and collective failure. We contribute to economic sociology by developing a socio-technical account that grapples with the new forms of sociality introduced by financial models - disembedded yet entangled; anonymous yet collective; impersonal yet, nevertheless, emphatically social.

Suggested Citation

  • Beunza, Daniel & Stark, David, 2012. "From dissonance to resonance: cognitive interdependence in quantitative finance," LSE Research Online Documents on Economics 45604, London School of Economics and Political Science, LSE Library.
    • Handle: RePEc:ehl:lserod:45604
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    File URL: http://eprints.lse.ac.uk/45604/
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    References listed on IDEAS

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    JEL classification:

    • F3 - International Economics - - International Finance
    • G3 - Financial Economics - - Corporate Finance and Governance

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