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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