Psychology of financial markets: mini-lecture (UCL)

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>> My name's David Tuckett and I work
in the Psychoanalysis Unit here at UCL.
About 10 years ago, I began to be interested
in bringing together psychology, economics and sociology
and in trying to understand behaviour in financial markets,
my interest being in instability and why there are booms
and crashes, which, as you know,
turned out to be quite a popular thing just at the moment.
So in 2007, actually leading up to the crash,
I interviewed some 50 of the top money managers in order to try
and understand something about the decision making context
in which they make their decisions to buy,
hold and sell financial assets.
What I found was as soon as you go in and talk to them is
that their work is characterised by how to deal
with uncertainty and ambiguity.
Conventional economic thinking does define uncertainty very
clearly, they have a term for it - Knightian uncertainty -
but having defined it, they then more or less ignore it
and go ahead by thinking that you can assess the future by use
of probability and so on.
This was what my people certainly tried to do,
but basically when they come to making real decisions,
they have to make guesses about the future and they have
to interpret information which is inherently ambiguous
so that any number
of intelligent people can perfectly reasonably reach
different conclusions about it.
They also have to be convinced about what they're doing
and the solution to that of course is
to make decisions bringing your emotions into play
so that you believe in what you are doing,
and this is an effective way of making decisions, but it means
that it isn't the same kind of decision making process
as one expects at a normal, rational type model.
So what I found was
that basically what these people are trying to do is
to find exceptional stories, things that really seem
to be having tremendous promise,
and at the same time, things which are safe.
Now of course in real life, that's actually more
or less impossible or at least it's only occasionally
that you find something which is both exceptional and safe
because the way the market is meant to operate is
that there's some kind of equilibrium between price
and the opportunities that are coming your way and the risks.
So this is quite interesting and
I found then that what they essentially did is tell
themselves stories about the data to the best
of their ability and also look around them
to see what other people are doing,
what else seems to be going on.
And this makes the market extremely vulnerable
to being taken over by stories at any time,
stories that something fantastic is happening,
because they fear to miss out in two ways.
Of course they fear to put their money in something
which is going to be worth nothing,
or at least becomes worth nothing.
But they also fear to miss out on something that you
or someone else is being successful.
So if they see something being successful, there are all kinds
of pressures on them to join in.
And this tends to mean that the market is going naturally to go
up and down like that by the nature of financial assets
because unlike a television or something you can buy in a shop -
where you buy it, you take it home, you use it -
with a financial asset,
it's actually ultimately not necessarily worth anything apart
from whatever you think it's going to be worth according
to what other people will want for it later.
And so this means that by definition they're volatile,
they move around, they create excitement, they create anxiety,
and then on top of that, you've always got the worry
that maybe you'll be left - as people were with bank shares -
holding something that nobody wants.
So the entire situation is one in which emotion, imagination
and fantasy seem to be interesting.
Now of course in a traditional economic model,
none of this kind of material is included,
even in the more recent so-called behavioural economics;
that looks at cognitive elements and so on,
not at this type of fundamental, emotional
and uncertain situation. So that what I'm going to be trying
to do with this new grant from the Institute
for New Economic Thinking is trying to deepen this work,
trying to look at a wider range of people and trying
to also think about ways in which we can devise experimental
and other situations to test some elements of a hypothesis.