Financial motivation & market efficiency
If I may be permitted a lapse into bloggertarianism, Polly Toynbee says something here that seems plain wrong:
Economists' reductionist view of humans as rational economic units is nonsense: people's motivations are just as often not financially motivated, which explains why economists are not very good at predicting even tomorrow's stock market movement, let alone the next crash.
This is a non sequitur. It is because people are financially motivated that stock market moves are unpredictable. In their desire to make money, people seek out anything that might help predict future share price moves. So, if they find something that might tell them that a share will rise tomorrow, they buy the share today. That causes its price to rise today, to a level from which tomorrow’s move will be unpredictable.
People don’t leave money on the table. They are financially motivated. This causes share prices to be unpredictable.
Let’s look at this the other way. Let’s assume share price moves are predictable; there‘s some evidence for this. Why might this be? One possibility is that rises are compensation for taking extra risk - whilst important in most contexts, we can ignore this here.
The other possibility is that people are irrational - for example, they cling to their prior belief that a stock is good, and so under-react to bad news; this can generate the disposition effect or post-earnings announcement drift.
But these effects arise because people are not purely financially motivated; they wish instead to be proved right. In not being financially motivated, people leave money on the table.
So, Polly is wrong. The fact that stock market moves are unpredictable is evidence that folk are financially motivated. Contrariwise, predictability - insofar as it exists at all - arises from non-financial motives. If people weren't financially motivated, economists would find it very easy to predict share prices.
Now, I’ll be the first to agree that people aren’t always motivated by narrow financial considerations. But to cite the unpredictability of share prices as evidence for this, as Polly does, is just daft.
People don’t leave money on the table. They are financially motivated. This causes share prices to be unpredictable.
Let’s look at this the other way. Let’s assume share price moves are predictable; there‘s some evidence for this. Why might this be? One possibility is that rises are compensation for taking extra risk - whilst important in most contexts, we can ignore this here.
The other possibility is that people are irrational - for example, they cling to their prior belief that a stock is good, and so under-react to bad news; this can generate the disposition effect or post-earnings announcement drift.
But these effects arise because people are not purely financially motivated; they wish instead to be proved right. In not being financially motivated, people leave money on the table.
So, Polly is wrong. The fact that stock market moves are unpredictable is evidence that folk are financially motivated. Contrariwise, predictability - insofar as it exists at all - arises from non-financial motives. If people weren't financially motivated, economists would find it very easy to predict share prices.
Now, I’ll be the first to agree that people aren’t always motivated by narrow financial considerations. But to cite the unpredictability of share prices as evidence for this, as Polly does, is just daft.
It's also really bad writing:
"people's motivations are just as often not financially motivated"
Motivations are motivated?
Posted by: Tom Freeman | August 19, 2008 at 01:59 PM
Top fisk.
Posted by: James Schneider | August 19, 2008 at 02:55 PM
Astonish us; find something worthwhile in the Potty ouevre.
Posted by: dearieme | August 19, 2008 at 06:30 PM
Just stop fisking Polly. It's not big and its not clever. Haven't you got anything better to do?
Posted by: Dipper | August 19, 2008 at 10:53 PM
Have to agree with the comment above. Having a pop at Polly for knowing SFA about economics? You're shooting fish in a barrel here my man.
Posted by: Shuggy | August 20, 2008 at 12:16 AM
The more people put the boot into Polly, the better. A lot of people take her drivel extremely seriously.
Posted by: Sean Hunter | August 21, 2008 at 08:51 AM