Mean Markets and Lizard Brains: How to Profit from the New Science of Irrationality
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Everyone from journalists to market pros are turning to behavioral finance to explain, analyze, and predict market direction. In contrast to old-school assumptions of cool-headed rationality, the new behavioral school embraces hot-blooded human irrationality as a core feature of both individuals and financial markets. The 2002 Nobel Prize in Economics was awarded to scholars of this new scientific approach to irrationality. In Mean Markets and Lizard Brains, Terry Burnham, an economist who has a proven ability to translate complex topics into everyday language, reveals the biological causes of irrationality. The human brain contains ancient structures that exert powerful and often unconscious influences on behavior. This "lizard brain" may have helped our ancestors eat and reproduce, but it wreaks havoc with our finances. Going far beyond cataloguing our financial foibles, Dr. Burnham applies this novel approach to all of today's most important financial topics: the stock market, the economy, real estate, bonds, mortgages, inflation, and savings. This broad and scholarly investigation provides an in-depth look at why manias, panics, and crashes happen, and why people are built to want to buy at irrationally high prices and sell at irrationally low prices. Most importantly, by incorporating the new science of irrationality, readers can position themselves to profit from financial markets that often seem downright mean. Mean Markets and Lizard Brains skillfully identifies the craziness that is part of human nature, helps us see it in ourselves, and then shows us how to profit from a world that doesn't always make sense.
of winning immediately after a jackpot is the same as on a slot machine that has gone years without a winner. The efficient markets hypothesis states that stock markets should be memoryless like an idealized slot machine. Nothing should predict the next day’s stock price changes. So if it were true that optimism preceded stock (and stock market) declines, then that would be evidence of market irrationality and market meanness. The Denial: The believers in the efficient markets hypothesis deny
in so far as it is not falsifiable, it does not speak about reality.”20 In order to reach the standard of hypothesis, an idea must be provable, which means that there must potentially be evidence that could disprove it. As we have seen, there is essentially no way to disprove the idea of efficient markets. Popper excludes unfalsifiable ideas as being outside of science, mere dogma. “Double, double toil and trouble; Fire burn, and cauldron bubble,” say the witches in Macbeth, associating bubbles
Dollars 117 * estimate from part of year FIGURE 6.1 The United States Consumes Far More Than It Produces Source: U.S. Commerce Department current account deficit. We’ve had a deficit for so long that we show the negative current account deficit as positive numbers. Because we can’t imagine a world where the United States consumes less than it produces, we measure the amount of profligacy, not its existence. Residents in the United States consume far more than they produce. In return for Saudi
dollar rose in value almost every day for years, and the airwaves were filled with negative comments on the euro. On October 17, 2000, Tony Norfield, currency analyst with ABN Amro said, “It is simply ridiculous for people to keep suggesting the euro is fundamentally undervalued. It isn’t.” At the same time, Jane Foley of Barclays Capital went on record with: “It is still the case that Europe needs to implement structural reforms more quickly. Until that happens and productivity improves,
reemerged from bankruptcy; the company was liquidated and stockholders lost every penny. The reporter asked the investor, “What were you thinking when you invested tens of thousands of dollars into Braniff hours before they went out of business?” The investor (and he was a professional) responded with, “I bought the stock because I thought it would go up in price.” Whenever I make an investment decision, I wonder if I am going to suffer the fate of the Braniff buyer. Will my purchase be at