computerization of finance

The Journal of Socio-Economics 37 (2008) 1076–1089 The financial simulacrum: The consequences of the symbolization and the computerization of the financial market Christophe Schinckus a,b,∗ a Department of Economics (CEREC), Faculte´s Universitaires St. Louis, Brussels, Belgium b Department of Economics (GRESE), University of Paris I Panthe´on, Sorbonne, Paris, France Accepted 1 December 2006 Abstract In a first step, we present the symbolic evolution of financial market that illustrates the growing “consumer- oriented” dimension of finance. We introduce then the technological evolution of finance, that derives from the growing computerization of finance. The third part of the paper shows that this double evolution in finance allows us to consider the financial market as a “hyper-market”. The financial market is then presented as a result of what Baudrillard calls a “hyper-reality”. In the last section, we show that this hyper-reality allows a plurality of theoretical interpretations of the financial reality. © 2007 Elsevier Inc. All rights reserved. JEL classification: G190; Z100; B410 Keywords: Symbolization; Computerization; Epistemology; Hyper-reality; Financial markets 1. Introduction The last three decades have been marked by a sharp and astonishing increase in the complexity of the financial reality. There seem to be two main causes to this evolution: the growing sophistica- tion of financial products and the effects of the technological progress on the financial interaction. In this paper, we propose to analyze the increase in immateriality of the financial reality due to the sophistication of the products and to the deep change in the organization of the financial marketplaces. ∗ Correspondence address: No. 43, Boulevard du Botanique, 1000 Bruxelles, Belgium. Tel.: +32 2 211 79 43; fax: +32 2 211 79 97. E-mail address: Schinckus@fusl.ac.be. 1053-5357/$ – see front matter © 2007 Elsevier Inc. All rights reserved. doi:10.1016/j.socec.2006.12.067 朱田 朱田 朱田 朱田 C. Schinckus / The Journal of Socio-Economics 37 (2008) 1076–1089 1077 In this paper, we will propose to conjoin social theory1 and financial economics by studying the impact of the growing marketing dimension and the technology not only on the financial reality but also on the way of producing knowledge in financial economics. We would like to show that the contemporary finance can be considered as a double evolution. First, we will see that the new “consumer-oriented” dimension of the financial market tends to favor a “symbolic evolution” of the financial reality where financial markets are more and more presented as a game that we have to play if we want to be “in”. The second evolution is generated by the com- puterization of finance. This technological evolution increases the immateriality of the financial reality and contributes to the dominance of the “consumer-oriented” dimension. These symbol- ization and computerization of finance lead to a reflexive and a self-referent evolution of the financial reality. By considering the financial market as a simulacrum, this paper is in line not only with the analysis of reflexivity in the economic life proposed by Lash and Urry (1994) but also with the anthropological works that present a embedded financial market in a cultural matrix that determines its forms of transaction (see Callon, 1998 or Knorr-Cetina, 2006). Finally, we will emphasize the epistemological consequences of this double evolution in the last sec- tion of this paper by showing that the contemporary evolution of finance favors a theoretical diversification. 2. Structure of the paper In the first section, we will see that the sophistication of financial products allows the devel- opment of a more and more “consumer-oriented” dimension of the financial market. We will also emphasize the fact that all this symbolic evolution has led to an increase of the specula- tive activities. The second section will be dedicated to an analysis of the computerization of the financial market. Some important applications of the new technologies in the financial market will be studied: the automatic trading and the e-finance. In the third section, we will use the term “hyper-market” to characterize the contemporary financial markets. We have chosen this term, on the one hand, to recall the “consumer-oriented” dimension of the contemporary financial places, and, on the other hand, to refer to the concept of hyper-reality developed by Baudrillard (1981). To conclude this paper, we will investigate the epistemological consequences of this double evolution of finance by studying the impact of what we call the new financial hyper-reality on the current evolution of financial economics. 3. Section 1: The symbolization of finance For the last three decades, financial innovation has become a very important dimension of the financial reality. We will see in the next section that the development of more and more complex products has been made easier by the progress in computer science that has decreased the calculation time. We will show in this section that the financial innovation illustrates the new “consumer-oriented” dimension of our contemporary financial reality. This new dimension tends to develop a specific meaning (trading for trading’s sake) of the financial reality where quotations become symbols with less and less connections with the productive sphere. 1 According to Giddens (1983), “Social Theory has the task of providing conceptions of the nature of human social activity”. According to Fincher (1987, p. 9), Social Theory proposes several “frameworks for explaining the reality we experience and we observe”. Fincher explains that these frameworks allows us “to develop explanations by linking people’s action in some way to the society of which those people are a part”. 1078 C. Schinckus / The Journal of Socio-Economics 37 (2008) 1076–1089 Jacquillat and Solnik (1995, p. 252) list more than 25 new financial products that have appeared recently. In consequence of this evolution, a prolific literature has emerged about financial innova- tion. Some authors try to understand and explain the financial innovation itself. Bettzu¨ge and Hens (2001), for instance, study the evolutionary dimension of the financial innovation by presenting the sophistication of the financial products as a result of the growing complexity of the investors needs. Moreover, one can find interesting surveys about the impact of the financial innovation on the financial markets themselves. According to Artus (1995, p. 44), the sophistication of the products (often combined with changes in the financial regulation as it is the case in France) tends to require a higher profession- alization of the assets holders. Artus first explains that this requirement has the effect to reduce the average investment horizon (because the performance of professional asset managers is often measured in the short term) and to favor mimetic behaviors (because asset managers are often evaluated on the basis of some market benchmarks). Moreover, according to Artus, the sophisti- cation has generated a higher volatility on the markets because the professional financial actors have generated an increase in the speculative activities compared to hedging activities. Because the variety and complexity of financial products enlarge the contemporary sphere of speculation, Shiller (2003, p. 14) considers also the increase in the speculative activities as a potential problem resulting from financial innovation. However, it is useless to provide more sophisticated products if nobody is ready to buy them. We must then not forget that the basic objective of these new products is to satisfy the growing complexity of the investors needs. The evolution of these investors needs may be influenced by a multiplicity of factors such as changes in the financial regulation or changes in the taxation system. Among these factors, one can also underline the increasing volatility of some macro-economic factors (interest rates, exchange rates, etc.) which have led investors to ask, on the one hand, for complicated hedging solutions, and, on the other hand, for complex speculative products to take profit from this high volatility. According to Orle´an (1999, p. 45), the emergence of complex products such as the derivatives has increased not only the liquidity but also the volatility of the financial (stock) markets.2 We can observe a self-referent mechanism where the new products tend to increase the volatility of the market and then to favor the emergence of new complex hedging solutions. The investment profiles are very diversified and even if hedging activities are still important, Orle´an (1999, p. 45) explains that finance tends to be more and more dedicated to speculative activities. He mentions that finance tends to leave aside its initial goals which were to raise capital, to finance entrepreneurial activities, or to hedge risk positions. That is why he evokes the “virtual character” of finance to express this disconnection with the productive sphere. About the contemporary legitimacy of speculation, it is interesting to mention Godechot (2001) who underlines the fact that speculation (not well accepted during the previous centuries) has been legitimized thanks to the contemporary belief in a economic equilibrium dictated by the financial markets. The sophistication of financial products is also said to have allowed a personalization of the financial services (Fain and Roberts, 1997). Indeed, the new financial products are supposed to satisfy the increasing complex needs of investors while at the same time, with the multiplication of the finance products, each kind of investors can find products in accordance with their specific financial needs. 2 Orle´an (1999, p. 45) recalls, by the way, that the concept of market liquidity is a socially constructed idea created by finance professionals. C. Schinckus / The Journal of Socio-Economics 37 (2008) 1076–1089 1079 According to Shiller (2003, p. 10), with the use of new marketing methods, financial products can now be advertised in a fashioned and consumer-friendly way. For instance, some financial products are presented as specifically created for a particular kind of investors as they are said to be optimally adapted to their risk profile. While some professionals try to take advantage of the preferences of investors for stocks of home-country firms (“home effect”), other professionals, on the contrary, praise the advantage of international diversification while advertising for a new international mutual fund.3 Inspired by Shiller (2003, p. 1) who explains that “we need to democ- ratize finance and bring the advantages enjoyed by the clients of Wall Street to the customers of Wal-Mart”, we could say that the contemporary evolution of the financial reality tends to democ- ratize finance and to bring the advantages enjoyed by the clients of Wall-Mart to the customers of Wall Street. Financial markets often appear to be more and more a matter of advertising. Lunt (2000) proposes a rhetorical analysis of several financial adverts (in England) from the early and the mid-1990s. This analysis of the financial adverts clearly shows the new “consumer-oriented” dimension of the financial services. Lunt explains that financial companies, by using adverts such as “if you want to be like a princess or like a famous footballer or if you want to be secure (for old people), you have to buy the financial services proposed by the company”, present financial products as a necessary condition to be “in”. Shiller (2000, pp. 101–129) emphasizes that the mass media have an impact on the investors’ behaviors. The financial markets are often presented as a casino where it is possible to become an important person exactly as some famous investors (whose life is presented as a fairy tale) did. According to us, the evolution of financial adverts and the influence of the mass media tend to favor the “symbolization” of the financial reality. All these elements that influence the investors’ behaviors are related to our specific culture and tend to emphasize the “consumer-oriented” reality by enhancing the symbolic aspect of investment. If we consider, following Shiller (1999), that investors pay much more attention to conversations, rituals and symbols, we can conclude that financial adverts and mass media are culturally dedicated to the symbolic (and hence material) perpetuation of the contemporary financial markets. The investors’ behavior tends to become more and more “symbolic” because it has meaning beyond that which is directly manifested. The recent marketing methods present the financial market as a “fashion game” that we have to play if we want to be “in” (Lunt, 2000) (where the quotations can be seen as conventions4). The financial innovation is often considered to be related to the emergence of e-finance which is claimed to also favor the speculative behaviors (Barber and Odean, 2001). In the next section, we will study the influence of electronic trading and e-finance on the financial reality. It seems obvious that these technological evolutions have the effect to intensify the virtual dimension of finance. 4. Section 2: The computerization of finance The technological mutations, mainly characterized by the emergence of the automatic trading and the creation of electronic financial products, have profoundly modified the organization of the markets but also, we will see, the financial exchanges themselves. We will show how these evolutions have generated what we call the computerization of the financial reality. 3 For more information about financial advertizing see also Jordan and Kaas (2002). 4 Quotations are not seen as an approximation of the fundamental values. 朱田 朱田 朱田 朱田 朱田 1080 C. Schinckus / The Journal of Socio-Economics 37 (2008) 1076–1089 Since 1980s, the greatest stock exchanges have been automated and auctions have been replaced by quotations determination algorithms.5 Computerization of finance refers to the fact that each financial marketplace has since then been equipped with an electronic trading platform. Tech- nically, such an electronic trading platform is an automated market which exercises some of all of the following functions: an “electronic order routine (the delivery of orders from users to the execution system), an automated trade execution (the transformation of orders into trades), an electronic dissemination of pre-trade (bid/offer quotes and depth) and post-trade information (transaction prices and volume data)” (Committee on the Global Financial System, 2001). First, the electronic trading has profoundly revolutionized the functioning of the financial mar- kets. For a few years, the organizational consequences of this technological evolution have been studied by several authors. Jiang et al. (2002) explain that the electronic trading has increased the operational and informational efficiency of the markets. Moreover, in the literature (see Claessens et al., 2002 or Jiang et al., 2002), the automatic trading is said to have reduced the transaction costs and increased liquidity. Tsang (1999) proposes a comparison between the traditional open outcry trading system and the automated trading system. He confirms the impacts evoked above and also underlines the better transparency generated. This transparency is also discussed by Jiang et al. (2002) who specify that the automated system “offers a greater transparency of the order book on prices and volumes way from the best bid and ask, which can reduce information asymmetry and provide more information for market-maker to manage their inventory exposure more effec- tively” (Jiang et al., 2002). Apparently, the only main drawback of the automated trading system is the fact that, despite its lower operating costs, it generates high development costs. Moreover, the order cancellation procedure may cause delays and discourage other orders. Finally, let us mention the eventual bug problems inherent to every computer-based system. Even if it is true that the automatic trading has considerably reduced the negotiation dimension of the financial exchange, it has not (yet) “dis-humanized” the financial exchange which is still based on human interactions. However, the oral negotiation has been replaced by a more abstract sociability because traders only interact via their computer screens (Godechot, 2001). Accord- ing to Lepinay and Rousseau (2001), there is a true “screen sociability” where traders tend to personify their screen by giving them a hypothetical personality. In a recent paper, Knorr-Cetina and Bruegger (2002) explain how the financial interaction has evolved since the emergence of the automatic trading. According to them, financial interaction can be reduced to the way the traders interpret the signals that appear on their computer screens. As regards this technological evolution of finance, we can also mention the researches of Nesbitt and Orenstein (1999) who have worked on the possibility and the potential impact of a multi-sensory human–computer interface. The second dimension of the impact of the technological progress in finance is the more recent electronic finance often abbreviated e-finance. There exists no broadly agreed definition of e- finance. Generally speaking, e-finance refers to financial services offered electronically, i.e. via Internet or via any other public networks. For several years, the number of products offered in this way has significantly increased. The online technology even allows for the creation of fully virtual markets. The “Iowa Electronic Market”6 (IEM), created in 1988, was the first virtual market. According to Varian (1998), the EIM was indeed the first market where all kind of interactions 5 “An algorithm is a set of finite and recurrent rules or instructions which can be executed by a machine. A quotation algorithm executes the orders according to an auction process and in accordance with a set of priorities”, in Muniesa (2000). 6 The Iowa Electonic Market is currently dedicated to derivative securities. For more information about this market, see http://www.biz.uiowa.edu/iem/index.html. 朱田 朱田 朱田 朱田 朱田 朱田 朱田 C. Schinckus / The Journal of Socio-Economics 37 (2008) 1076–1089 1081 took place online. Through the years, this evolution towards virtual markets has extended to other regions of the world. The virtual financial infrastructure called “FinNet”7 developed in Hong Kong in 2002 is a good example of this evolution. Governed by a public–private partnership, “FinNet” is a network interconnecting investors with all institutions established in Hong Kong. It means that investors have simultaneously access to all types of financial services that are available in Hong Kong. According to Claessens et al. (2002), even if there exists a variety of factors (the telecommunication infrastructure for example) determining the development speed of the electronic technologies in each country, more than 90% of the financial products should be available online in 2010 in the industrialized countries. The authors also explain that the trend towards e-finance is observed all over the world even in countries where the financial infrastructure is poorly developed. e-Finance is profoundly impacting the functioning of the financial markets. Claessens et al. (2002) explain that e-finance generates a decrease in the transaction costs and in the costs related to marketing and intermediation and increases the competition as it becomes much easier for investors to compare the advantages of all types of financial products and to compare the fees charged by all financial institutions. By reducing the transaction costs and the financial inter- mediation, e-finance will allow more customers to have access to various financial