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The Taylor Rule: Ignore Fraud Epidemics and Worship Markets

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"The crisis did not reflect some inherent defect of the market system that needed to be corrected, as many Americans have been led to believe. Rather it grew out of faulty government policies."


The VIX index can be driven by many variables.  I believe it is increased appreciation of the extent and nature of risk, particularly fraud risk, rather than risk aversion changes, that is the primary driver of extreme changes in the VIX index.  I do not believe that even if there were a reliable VIX S&P 500 stock option index and even if it could be reliably decomposed to quantify stock aversion changes among the purchasers of those options that the index would explain the behavior of the CEOs that led the three massive epidemics of accounting control fraud that hyper-inflated the bubble and drove the crisis.  There is no evidence that these CEOs decisions were the product of changes in the CEOs' risk aversion, but the relevant means by which the CEOs leading the frauds changed risk was by using a fraud scheme that greatly reduced the risk of detection and sanction and by using their political power to maximize the three "de's."  The rate of growth of the money supply (Taylor's fixation) has nothing to do with the risk aversion of the CEOs that led the three fraud epidemics.  Neither Taylor nor the ECB authors understand the relevant nature of the CEOs' risk aversion or how the CEOs that led the three epic control fraud epidemics minimized their risk while greatly increasing the firm's risk of loss.

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William K Black , J.D., Ph.D. is Associate Professor of Law and Economics at the University of Missouri-Kansas City. Bill Black has testified before the Senate Agricultural Committee on the regulation of financial derivatives and House (more...)

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