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Financial Economics Ruminations

May 21, 2019

Finance and economic theorists commonly make simplifying assumptions in the process of developing their theories and interpretations about the way the world works, and to forecast how economic agents would react to changes in the economic environment. In the next few paragraphs we examine how some of the conclusions yielded by different theories are dependent on the simplifying assumptions made by the theory developers. If they are, then we should be suspect of the conclusions and insights yielded by the analysis. On the other hand, if the results are robust enough to be unaffected by the simplifying assumptions, then we should give them higher weight than the assumption dependent conclusions. Ultimately the usefulness of the analysis depends on the results produced by the approaches using the simplifying assumptions.

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