One aspect of international travel that I truly enjoy is reading about the business world from a different perspective. On my trip to Sydney, Australia earlier this month, I dug through local papers and The Australian Financial Review to get a sense of how the current economic challenges where being felt and understood in Australia. I look forward to getting a different perspective next month when I head to South Africa.
I found in interesting article in an insert magazine in The Financial Review. The insert magazine is rather amusingly called Boss. In the article, Mike Hanley did a wonderful job explaining the limits of the efficient markets logic. A key limitation is that markets consist of human beings and human perception of risk is predictably irrational. These pervasive cognitive biases were revealed in the research of Nobel Prize winners Daniel Kahneman and Amos Tversky. Kahneman and Tversky demonstrated how we can be easily manipulated to become risk-seeking or risk-averse, how we over value confirming data and discount disconfirming data, and how we are overconfident in our knowledge and decisions.
I find it interesting to consider the implications of Kahneman and Tversky’s work for the financial markets. Because these biases are so ingrained and pervasive, we cannot rely on the ‘wisdom of the crowd’ to save us. A majority of the crowd will suffer from these same biases and it is folly to simply hope these biases will counteract each other. Rather, what is needed is a system designed to offset these human cognitive tendencies. I certainly do not pretend to have the answer of what that system would look like. However, it would surely include mechanisms to limit considerations of sunk costs, counteract confirmation biases and reveal limitations of investor information.
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