This week was made interesting by the US financial markets and Chapter 11. And if all the bad news wasn’t enough Google and Chicago Tribune made it more happening by letting everyone think that United Airlines had filed for bankruptcy too to cut costs.
I will let Chicago Tribune give you the story in detail, that sort of fits anyway. Just to give you a gist
The steep sell-off in United’s shares came after a news service in Florida distributed an old story posted on the South Florida Sun-Sentinel Web site six years ago. Monday’s recirculated story gave the appearance that United had filed for bankruptcy protection again. In fact, the story was originally published Dec. 10, 2002, by the Chicago Tribune, marking the airline’s decision at that time to seek protection from creditors.
And more importantly for us, moments after a headline for the story hit Bloomberg, shares in United stock fell from about $12 a share to a low of $3, prompting a halt in trading of United stock.
Of course, once the truth was out the stock got back to a slightly lower $10 odd and will probably now reach its market value of $12 and might start trading in a regular manner.
What Happened Here?
What we saw was a perfect simulation of Panic Selling and to a certain extent noise trading. I intend to cover these two in details later (so watch this space for that).
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The gambler’s fallacy is the mistaken notion that the odds for something with a fixed probability increase or decrease depending upon recent occurrences. The gambler’s fallacy involves beliefs about sequences of independent events.
By definition, if two events are independent, the occurrence of one event does not affect the occurrence of the second. For example, if a fair coin is flipped twice, the occurrence of a head on the first flip does not affect the outcome of the second flip. What if a coin is flipped five times and comes up heads each time. Is a tail “due” and therefore more likely than not to occur on the next flip?
Since the events are independent, the answer is “no.”
The gambler’s fallacy believing the answer is “yes.”
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Economists believe the perception of risk to be the most important factor in investor decision making. Investing decisions are always taken on the basis or the amount of risk involved in the investment. I.e. two people when given the same amount of money needn’t necessarily invest in the same manner. The reason is the perception of risk and the need of the investor. What can be percieved as a huge risk by someone may be the minimum risk involved as perceived by someone else. And some might be willing to bear the effects of the risk involved, while some may not.
Thus practitioners of behavioural finance and finance advisors need to understand the level or the risk perception that their client carry in their mind and need to design investment methods on the same basis. Hence, an understanding of risk and its characteristics is an integral part of behavioural finance.
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