Copycats and Contrarians_Why We Follow Others... And When We Don't by Michelle Baddeley

Author:Michelle Baddeley [Baddeley, Michelle]
Language: eng
Format: epub
Tags: Psychology
ISBN: 9780300220223
Amazon: 0300220227
Goodreads: 36004721
Publisher: Yale University Press
Published: 2018-07-10T00:00:00+00:00

Beauty contests

Financial herding is also driven by speculators’ attempts to second-guess what others are thinking. When we are deciding what we are prepared to pay for an asset, especially if we intend to sell it quickly, what other people are willing to pay for it is a good anchor for our own judgement about what we should pay. Others’ willingness to pay will determine the price we might be able to achieve if we are selling the asset ourselves. Keynes described this phenomenon using the metaphor of a beauty contest.22 He imagined a newspaper competition in which readers are asked to look at some photos of women and then judge not who they personally think is prettiest, but who they think other readers think is prettiest. Keynes argued that a similar process describes financial speculation: speculators buy stocks and shares at seemingly exorbitant prices not because they independently believe that these assets are really worth that much, but because they believe other speculators are prepared to pay similar prices.

Speculators’ preoccupation with others’ opinions has a reasonable basis. Ultimately, speculators are in the business of buying and selling assets to make a profit. They are also trading in fast-moving, highly liquid markets and they want to be able to sell very quickly, so they need to be able to match the price expectations of other traders around them. Speculators cannot afford to wait too long to find someone whose ideas about the fundamental value of an asset match their own. So, the individual speculator decides that their own convictions and judgements are largely irrelevant. For them, it is more important to know how much others are prepared to pay. How much do others think others are prepared to pay? How much do others think others think others are prepared to pay? How much do others think others think others think others are prepared to pay? And so on and so on. Keynes argued that, with everyone worrying about what everyone thinks everyone else is thinking, financial markets are not founded strongly on people’s careful assessment of the likely prospects of different assets. In fast-moving financial markets, carefully assessing the facts determining the fundamental value of an asset does not help speculators to make money. Predicting what others think might.

Modern economists have adapted Keynes’ metaphor in their theories of iterated reasoning. We form our beliefs about a collective judgement, for example about the price of a share, by iterating from one person to the next. For example: imagine I try to predict what Abu thinks a share is worth, while Abu is trying to figure out what Bob thinks it’s worth. Bob is trying to figure out what Chandra thinks it’s worth, and Chandra is trying to figure out what Des thinks it’s worth, and so on. As for me, I have to figure out what Abu thinks Bob thinks Chandra thinks Des thinks it’s worth. A lot of cognitive effort is required to figure out what the crowd, as a whole, thinks about the value of a share.

Download

Copyright Disclaimer:
This site does not store any files on its server. We only index and link to content provided by other sites. Please contact the content providers to delete copyright contents if any and email us, we'll remove relevant links or contents immediately.