Check out the video: Misbehaving
When Richard Thaler and Werner De Bondt published a 1985 study in the Journal of Finance called “Does the Market Overreact?,” it was borderline heresy to suggest the markets weren’t completely rational and efficient. Anyone who’s paid even passing attention the past 20-odd years knows financial markets are prone to bouts of what Alan Greenspan called “irrational exuberance” and it’s pessimistic counterpart. And, yet, “there are still people clinging to the belief markets are perfectly rational all the time despite what we’ve seen the last 20 years,” Thaler says.
Ironically, the idea that supposedly learned people would believe something despite mountains of contrary evidence is something behavioral economics, the field Thaler and De Bondt helped birth, would at least try to factor into the analysis.
Thaler’s last book, Misbehaving, is an attempt to explain the origins of behavioral economics and “to explain some of the things we learned along the way.” Among those lessons are two the University of Chicago Booth School professor says are particularly relevant to investors:
“One, you can learn a lot about yourself by studying the mistakes everybody else makes because you’re no different than everyone else. You’re probably not going to beat the market – even if you watch Yahoo Finance religiously you don’t really know more than everyone else.”
“Two, markets have these wild swings and people have a tendency to extrapolate the past into the future. When real estate prices were booming in places like Vegas…you’d hear people say ‘Real estate prices always go up, I can’t lose’. As soon as you hear that, it’s time to get out.”
These truths may seem self evident but, again, “the idea that there are people out there and they’re not all as smart as the smartest economists wouldn’t seem to be particularly controversial,” Thaler quips. But it is in certain circles, including the realm of public policy where Thaler notes economists have a “virtual monopoly” on advising elected officials and policymakers.