Real Options 'in' Economic Systems: A Proposed Resolution to Problems in Modern Market and Neo-Classical Economic Theory

Abstract

“I contend that rational expectations theory totally misinterprets how financial markets operate. Although rational expectations theory is no longer taken seriously outside academic circles, the idea that financial markets are self-correcting and tend towards equilibrium remains the prevailing paradigm on which the various synthetic instruments and valuation models which have come to play such a dominant role in financial markets are based. I contend that the prevailing paradigm is false and urgently needs to be replaced.” George Soros. 2008.This conceptual paper will take on the Soros challenge, using the concepts and methodologies of “real options in economic systems” and adding fresh thinking about data sources and the meaning of risk. It will examine the shortcomings and fallacies associated with modern portfolio and capital market theory and neo-classical economics and ask many disquieting questions. General solutions, based in real options thinking, will be proposed and extended to the outer edge of global economic systems as found in the underground economies of the developing world.