Epistemic Limits of Empirical Finance: Causal Reductionism and Self-Reference

This paper, "Epistemic Limits of Empirical Finance," argues that traditional quantitative finance methods, which rely on unidirectional causality, may be inadequate for understanding financial markets. The authors explain that markets are "reflexive" systems, meaning they are self-referential and can be influenced by the very act of analyzing them. This reflexivity creates feedback loops that make it difficult to isolate and identify clear causal chains. They use the analogy of a predator-prey relationship in ecology to illustrate how the interplay of multiple causal factors can lead to complex and unpredictable dynamics. The paper concludes that, while quantitative finance tools have value for ex-post analysis, their ability to predict future market behaviour is limited by the inherent reflexivity of financial systems.

The paper is here: https://arxiv.org/pdf/2311.16570

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