This fall in fund performance then gives rise to a second feedback loop, inducing investor withdrawals from those funds which have under-performed, further reducing demand for the bond and amplifying the fall in its price. It is only after some time that the influence of value investors stabilises the market. Each individual run of the model is like hitting a wild horse once and has an unpredictable outcome. But we can get an idea of the general behaviour of the funds by running the same scenario repeatedly – if you like, hitting the wild horses hundreds of times and looking at their most likely response. The most likely behaviour of funds in this model-market are oscillatory, with shocks amplified in the short run and only damped after a period of several hundred days (Chart 14). But by rolling the dice over and over again, we can also look at the distribution of possible outcomes, as the average may hide extreme behaviour in the tails. For example, if the fraction of passive investors increases, this dampens average changes in bond yields (Chart 15). But it also increases the chances of much bigger changes in yields – the tails of the distribution fatten. 34  All speeches are available online at www.bankofengland.co.uk/publications/Pages/speeches/default.aspx  34  Chart 14: Impact of a shock to the expected loss rate  Chart 15: Distribution of outcomes after a shock to the expected loss rate  Source: Braun-Munzinger et al (2016).
Both approaches have their place in making sense of the dappled economic and financial world. But, to date, both have not been given equal billing. The global financial crisis is an opportunity to rebalance those scales, to take uncertainty and disequilibrium seriously, to make the heterodox orthodox. A profession that has, perhaps for too long, been shackled needs now to be Shackled.