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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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§ August 26th, 2008 § Filed under Concepts
Prospect theory proposes a framework for the way people make decisions under conditions of risk and uncertainty. Prospect theory embodies a richer behavioral framework than that of subjective Expected Utility Theory which underlies many economic models. Prospect theory has probably done more to bring psychology into the heart of economic analysis than any other approach.
Unlike much psychology, prospect theory has a solid mathematical basis — making it comfortable for economists to play with. However, unlike Expected Utility theory which concerns itself with how decisions under uncertainty should be made (a prescriptive approach), prospect theory concerns itself with how decisions are actually made (a descriptive approach).
Prospect theory was created by two psychologists, Kahneman and Tversky, who wanted to build a parsimonious theory to fit a number of violations of classical rationality that they and others had uncovered in empirical work.
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§ August 24th, 2008 § Filed under Concepts
The term quasi-magical thinking, as defined by Shafir and Tversky (1992), is used to describe situations in which people act as if they erroneously believe that their actions can influence an outcome (as with magical thinking) but in which they in fact do not believe this. It includes acting as if one thinks that one can take actions that will, in effect, undo what is obviously predetermined, or that one can change history.
In investing, quasi magical thinking can be felt or seen in the way investors sometimes decide to buy or sell stocks. They may do a certain action before making a purchase, take God’s name before making any transaction, wear their left socks first, though they do realize that they do this for their own satisfaction and it does not bear any effect i.e. information-wise in the result of the trade. They do it with the belief that such an action can correct any mistake or help them in not making a mistake, though it seldom happens that way.
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§ August 19th, 2008 § Filed under Concepts
As I have mentioned often on my posts, traditional economics and finance consider agents or investment participants to be rational and that there are no frictions, i.e a security’s price equals its “fundamental value”. This is the discounted sum of expected future cash flows, where in forming expectations, investors correctly process all available information, and where the discount rate is consistent with a normatively acceptable preference specification. The hypothesis that actual prices reflect fundamental values is the Efficient Markets Hypothesis (EMH).
In an efficient market, there is “no free lunch”: no investment strategy can earn excess risk-adjusted average returns, or average returns greater than are warranted for its risk. Behavioural finance argues that some features of asset prices are most plausibly interpreted as deviations from fundamental value, and that these deviations are brought about by the presence of traders who are not fully rational.
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§ August 16th, 2008 § Filed under Concepts
In the psychological literature there is no precise definition of overconfidence. There are several findings that are often summarized as overconfidence. Under this view, which is the broadest possible that can be found in the literature, overconfidence can manifest itself in the following forms: miscalibration, the better than average effect, illusion of control, and unrealistic optimism. As an investor you might find yourself in such situations often and perhaps not realize that you are showing signs of overconfidence while making investment decisions. The trick is to realize it or to see it in others to make the most of an investment opportunity.
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§ June 15th, 2008 § Filed under General
As a student of finance, I had seen some interesting days on the stock markets, and some interesting debates about it in college. There were times when an impressive stock took a beating despite performing well. Then there are those penny stock bubbles that come up often that just beats us on how they find investors to pump in the money.
This threw a few interesting questions, and they often caught my fascination. Why do some stocks get beaten even when results are seemingly attractive while seemingly worthless shares attract money? What drives stock prices? What drives investors’ decision making?
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