Tuesday, 15 February 2005

Irrational investors

I've been following Henry Blodget's financial column in Slate with interest, including this one where he makes quite a comprehensive list of all the reasons from behavioural finance why investors might behave irrationally.

The underlying ideas in Blodget's work make sense in a lot of other fields of life too - I would say conservatism bias and confirmatory bias (respectively, the idea that we tend to overvalue information that reinforces our opinions and undervalue information that undermines them, and the idea that that we seek out information that supports our opinions) helps perpetuate stereotypes, for instance.

One thing that I thought about after reading the article: if prospect theory is right and we value losses way more than gains (i.e. expected returns have to be much higher than expected losses), why do people buy lottery tickets? Either people have a really hard time fathoming minuscule odds and overweight their odds of winning (the Kahneman and Tversky argument, if I recall correctly - some elucidation here), or the act of buying the ticket and dreaming about what you'd do with the winnings gives inherent pleasure. Well, I'll tell you what it is when I win that $10 million Toto jackpot...

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