Phantastic phinance

It's hardly a secret that the rational agent hypothesis of neoclassical economics is, at best, an idealisation; and, at worst, a dangerous myth. It's much the same for the rational investor of finance theory, as backed up by a host of behavioural studies.

You don't need to have experienced many investment bubbles, crazes and panics to appreciate that. Some diehards have claimed that bubbles can be understood as rational phenomena, but that always seems like stretching the definition a little too far.

It's interesting then to get the psychoanalytic point of view on a question that has been dominated by economists. David Tuckett of UCL and Richard Taffler of Edinburgh Uni have a paper in the new International Journal of Psychoanalysis with the delectable title Phantastic objects and the financial market’s sense of reality: A psychoanalytic contribution to the understanding of stock market instability.

Tuckett lays it out in the UCL press briefing:
“Feelings and unconscious ‘phantasies’ are important; it is not simply a question of being rational when trading. The market is dominated by rational and intelligent professionals, but the most attractive investments involve guesses about an uncertain future and uncertainty creates feelings. When there are exciting new investments whose outcome is unsure, the most professional investors can get caught up in the ‘everybody else is doing it, so should I’ wave which leads first to underestimating, and then after panic and the burst of a bubble, to overestimating the risks of an investment.

“Market investors’ relationships to their assets and shares are akin to love-hate relationships with our partners. Just as in a relationship where the future is unexpected, as the market fluctuates you have to be prepared to suffer uncertainty and anxiety and go through good times and bad times with your shares. You can adopt one of two frames of mind. In one, the depressive, individuals can be aware of their love and hate and gradually learn to trust and bear anxiety. In the other, the paranoid schizoid, the anxiety is not tolerated and has to be detached, so the object of love is idealised while its potential for disappointment is ‘split’ off and made unconscious.

“What happens in a bubble is that investors detach themselves from anxiety and lose touch with being cautious. More or less rationalised wishful thinking then allows them to take on much more risk than they actually realise, something about which they feel ashamed and persecuted, but rarely genuinely guilty, when a bubble bursts. Again, like falling in idealised love, at first you notice only the best qualities of your beloved, but when everything becomes real you become deflated and it is the flaws and problems that persecute you and which you blame.

“Lack of understanding of the vital role of emotion in decision-making, and the typical practices of financial institutions, make it difficult to contain emotional inflation and excessive risk-taking, particularly if it is innovative. Those who join a new and growing venture are rewarded and those who stay out are punished. Institutions and individuals don’t want to miss out and regulators are wary of stifling innovation. If other investors are doing it, clients might say ‘why aren’t you doing it too, because they’re making more money than we are’.”

That last point seems to bring us into the realm of situational psychology. I've recently been reading Phil Zimbardo's The Lucifer Effect on that area - an interesting and disturbing read. Most of the behavioural finance studies I've read (or, at least, read about) concentrate on the personal biases and heuristics that affect individual decisions - the effects of peer pressure and groupthink on economic decision-making seems a fruitful area for further study.

Grounded

The Sheffield Star marks what is probably the last flight from the city's airport, with a look back at its troubled history.

Meanwhile, steel boss Andrew Cook has stepped up as the erstwhile mystery backer of the save-the-airport lobby (Sheffield City Airport Movement, aka SCAM), which is still chasing the legal route:
They are then hoping for a full court hearing to consider whether owner Peel Airports and Sheffield Council abided by conditions which stated the airport - which opened in 1997 - had to be kept operational for 10 years and "all reasonable efforts" had to be made to attract airlines.
Mr Cook said: "The reason I am doing this is because I think it borders on madness for a city the size of Sheffield to give up its airport without a fight.
"I think it is an abomination that something that should be regarded as a valuable municipal facility should be thrown away."

Of balls and busts

It's not often that neuroscience/economics research hits the headlines, but a paper in this week's PNAS, concerning hormonal influences on the behaviour of individual stock traders, has sired prominent stories in many of today's organs - see, for instance, the Guardian or BBC.

The research is be John Coates and Joe Herbert of Cambridge uni. Their abstract sums it up nicely:
Little is known about the role of the endocrine system in financial risk taking. Here, we report the findings of a study in which we sampled, under real working conditions, endogenous steroids from a group of male traders in the City of London. We found that a trader's morning testosterone level predicts his day's profitability. We also found that a trader's cortisol rises with both the variance of his trading results and the volatility of the market. Our results suggest that higher testosterone may contribute to economic return, whereas cortisol is increased by risk. Our results point to a further possibility: testosterone and cortisol are known to have cognitive and behavioral effects, so if the acutely elevated steroids we observed were to persist or increase as volatility rises, they may shift risk preferences and even affect a trader's ability to engage in rational choice.

It's not a new concept, of course - I wrote about a related behavioural economics study two years ago (a post that, because of the title, is actually one of my most frequently accessed items by people coming to this blog via search engines - I suspect most of them will be disappointed).

And it doesn't take a genius to spot why this is now a lot more newsworthy - boom and bust economics seems to be on people's minds...

Sheffield malarkey latest

Updates on a couple of long-running Sheffield development stories -

Alexandra Topping reports in the Guardian on the doomed battle to preserve the Tinsley towers, or at least to erect some meaningful public art in their place:
The Tinsley cooling towers - bleak, elegant, real - are often the first and last thing people see as they enter and leave the city. But soon, like Sheffield's industrial golden age, they will be consigned to history, demolished to make way for a new power station. [Tom James of the Go magazine] reflects: "Imagine, when the towers are gone, Meadowhall will be the only thing you'll be able to see from the tram and the M1. How depressing."

And I hear there's much discontent, in some fairly high-up places, about the Peel Group's controversial purchase and closure of Sheffield City Airport. While it's probably too late for Sheffield, the group's finding its proposed plans elsewhere are undergoing a bit more scrutiny than they're used to. Not much substantiated at the moment, but could be worth looking into...