Folly Of Behavioral Finance & Behavioral Economics

Experimental evidence has shown that human beings are not always rational. This has led some economists and investors to believe that a new science of choices that takes into account the irrationality and arbitrary nature of certain human choices have to be taken into account while making rational choices for oneself. These economists and investors have thus embarked on an attempt to model how the market and its individuals behaves rather than how they ought to behave. The are on the “is” side of the David Hume’s is-ought dichotomy. They believe “is” is more powerful, pragmatic than “ought to be”.

However they fail to realize that by the essence and nature of existence, in the long run, all “is” will be what all “ought to be”. This has led them to believe economic ideologies and principles which has guided the free market for the past centuries, (like value investing) were merely serendipity.

Thus they laid the groundwork philosophy behind techniques like technical analysis and econometrics, and assumptions like the efficient market hypothesis.

Although these quants did initially profit from the madness of the masses, little did they realize that there is a method to the madness that their models can never cope with. I like to call it the “determinators dilemma”: Any public statement about the ways the masses tend to behave irrationally will sooner or later become invalid because the masses can choose to be contrarian.

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Where Do Determinants Come From?

If you do Gauss-Jordan elimination to find the inverse of \left( \begin{array}{ccc} a & b & c \\ d & e & f \\ g & h & i \end{array} \right) you will get

\left( \begin{array}{ccc} \frac{-f h+e i}{-c e g+b f g+c d h-a f h-b d i+a e i} & \frac{c h-b i}{-c e g+b f g+c d h-a f h-b d i+a e i} & \frac{-c e+b f}{-c e g+b f g+c d h-a f h-b d i+a e i} \\ \frac{f g-d i}{-c e g+b f g+c d h-a f h-b d i+a e i} & \frac{-c g+a i}{-c e g+b f g+c d h-a f h-b d i+a e i} & \frac{c d-a f}{-c e g+b f g+c d h-a f h-b d i+a e i} \\ \frac{-e g+d h}{-c e g+b f g+c d h-a f h-b d i+a e i} & \frac{b g-a h}{-c e g+b f g+c d h-a f h-b d i+a e i} & \frac{-b d+a e}{-c e g+b f g+c d h-a f h-b d i+a e i} \end{array} \right)

Determinant of \left( \begin{array}{ccc} a & b & c \\ d & e & f \\ g & h & i \end{array} \right) is -c e g+b f g+c d h-a f h-b d i+a e i. This also happens to be the denominator of every term in inverse above. So now you know where determinant comes from. It is the denominator that results when you Gaus Jordan elimination on any square matrix.

How To Walk On Water Like Jesus

Before we start, here is John 6:16-21:

16 Now when evening came, His disciples went down to the sea, 17 got into the boat, and went over the sea toward Capernaum. And it was already dark, and Jesus had not come to them. 18 Then the sea arose because a great wind was blowing. 19 So when they had rowed about three or four miles,[a] they saw Jesus walking on the sea and drawing near the boat; and they were afraid. 20 But He said to them, “It is I; do not be afraid.” 21 Then they willingly received Him into the boat, and immediately the boat was at the land where they were going. (John 6:16-21, New King James Version)

Footnotes:

  1. John 6:19 Literally twenty-five or thirty stadia

What you need:

  • Disciples
  • Boat
  • Long rope of the type used to tie the boat
  • Dark environment. Preferably moderately bad weather which can add to the low visibility.

Here is how to do it:

  1. Tie the boat to the dock with the long rope such that it is hard to see the knot on the boat and on the dock. Sink the loose rope in water.
  2. Ask the disciples to sail away and tell them you will catch up.
  3. Let them sail in the low visibility environment unable to track their relative movement with respect to the land.
  4. When the rope is taut, walk on the rope towards them. You need to practice some rope walking skills.
  5. Untie the boat from the long rope discreetly after you have got on the boat. Soon you & your disciples will sail on the boat to your destination.

Singapore Taxi Driver Socialism

Recently when I took a taxi ride, the driver complained that in Singapore, one must pay for everything, nothing is for free.

I asked him whether he’d be willing to drive me for free. I explained to him that even in welfare states people pay 60% taxes to enjoy free stuff. Everybody got to pay for what they want, either to the government or to an individual.

It is the liberal idea that centralizing resource distribution is better than decentralized resource distribution that I don’t understand. Have they not experienced the centrally planned economies of the past?

The recent results from MIT about computational complexity of computing Nash equilibrium shows once again the impossibility of a centrally planned economy. When will people grow up from this childhood and start assuming personal responsibility?

The Land Of Strikes

Recently my native city had a bus strike in which private bus owners stopped running buses because the government wouldn’t let them freely choose ticket prices conducive to sustainable operation. This is not the first time this has happened and it explains the short-comings of a mixed economy i.e. an economy in which the government controls economic freedom. A freedom with controls is not freedom.

Perhaps one day, Indian government will realize that they ought not to be regulators, but be facilitators of economic activity. I pray that day comes soon.