Saturday, March 03, 2007

rock concerts and capital markets

Although I say this to convince myself, let the others be privy too: Academicians aren’t always that boring. While spending their lives doing research, examining studies, and developing frameworks with quirky names, they sometimes freak out and do something worthwhile like attend rock concerts. 2 such rather sociable geeks, at a concert, question banks that they were, funnily wanted to know the reason for the huge attendance. They asked, “Are people here because of their personal/individual choices or is there a collective preference that drives mass choices?” After an analysis they proposed the theory (in ways you wouldn’t want to rack your brains about) that most individuals were influenced by their immediate environment—friends, family, place, etc. These people then made their choices, which is to say they duplicated those of a few others, and thereby formed groups based on such common behavior or herd mentality. Slowly, such groups grew in number and size. If things went adequately well, many stable groups sprouted, and the concert was a hit, or at least the tickets were sold out.

This inference just whetted the appetite of the geeks in question; they then attempted applying it to a more understandable field—economics. Capital markets. They studied how individual investors made their choices.

Investing in the stock market simulated attending a rock concert. What?
Investors were swayed by a similar process of “imitation.” How?

Initially, a few enthusiastic potential investors tried to make sense of the financial condition of firms: balance sheets, revenue statements, and the likes. These enterprising ones realized that they understood ECG reports better than all those annual statements. All that financial information didn’t light a Mentos bulb in the brain (those big bands you somehow didn’t have a clue about: awesome bass, brilliant rhythm, strong vocals?) So, they did the next best thing. They looked at others with similar interests (friends, family) and tried to imitate the ones who were making the most in stock markets or were sure of big payoffs (the most die-hard fan maybe, who made you feel that the concert was really worth something). In the market, such entities were the big institutional investors, funds, or even high net worth individuals. On a more specific level, the investors matched sectors, discerned trends, and made their choices (better rock than Carnatic; this alternative shit is in, man). That is, they decided upon whom to follow. This started a process. Each of them in turn influenced several others and a group began to be formed. Such a group, and many such groups, snowballed, witnessed a sedated increase, or just sank, depending on the spread of information. New members begot newer ones. More people, more money, more secure investments. The value of corporations swelled (tickets of the concert sold at inflated prices).

However, there was a hitch. Not everyone in a group was of the same stature. The old ones, the more experienced ones, if geometrically represented, lay in the centre of the group. The newer ones, ones with low investments or a more roving eye, sat on the fringes. These peripheral members were the ones who, maybe, had eggs in other baskets and were weighing the more lucrative baskets among them (a cheaper concert of a lost pop group (Viva?), or a 4 starred movie reviewed in TOI (K3G?)). These fringe members were the most liable to change. Their decisions could be easily swayed, any change in them easily triggered. Now say, investor X, a very old investor/fund/institution moved out of the group. All of a sudden, the value that had been built up fell (your rocker friend, the one whom you thought was crazy about the band, around whom your group of friends revolved, decided to sell his ticket). The confidence of other lesser investors dwindled. Their choices (imitation) were now changeable. If all this happened quickly enough, a collapse in the group(s) was triggered. Investments were pulled out with immediacy and market erection shrunk.

Now, a little peek into the past. Ethical accounting practices have been perceived to be important. Firms released true, accurate information on their financial condition. But sadly, since the average investor couldn’t differentiate chalk from cheese, all that voluminous financial truth made little sense. This sowed the seeds of collusion between accounting firms and companies. Shady stuff like window dressing and creative accounting happened (tweaked information was spread: 6 million copies of the band’s last album, which perhaps included 3 million pirated copies in China that didn’t bring a penny to the label). And while all this went on very dynamically, we, even the Economic Times conversant ones, saw the effects of such deep, widespread causes turning awry only when we, surfing channels, heard about the bankruptcy of Enron or World.com one fine morning.

However, capital markets, free markets, possess stable self-correcting mechanisms. So, even if false information is disseminated, investor interest is revved up, which is what ultimately matters. If this hype is strong enough, the stocks in question perform and people make money. Purists would say the market fundamentals are shaky, or that it is being driven by temporary bullish runs (your die-hard pro-Kishore Kumar uncle would proclaim that this rock-shock won’t last, quality music is what will eventually be heard).

However, what about spontaneous order: the social theory that says individuals follow their own self-interest, without a central authority designing a “plan” for everyone, thereby creating an ordered system? Don’t free markets subscribe to this?

Perhaps, what constitutes a voluntary choice isn’t really clear. But, anyway, the next time you decide on something, ask yourself how you really made that choice. And dont forget nerds can be cool too.

7 comments:

SUCHARITA ROY said...

My fatehr, an academician out of touch with reality bought shares from UTI 12 years back on the sound advice of my cousin who handles all his finance ventures ( that is this one only)...it went thru the days of the bull and the days of the bear...he neither pulls out nor does a thing about it. while my cousin has increased his shares from one to many..and earns a good benefit.in college doctors buy shares in bunches...just like you mentioned...most of thier money is put into banks in good old pass books or even FDs.its mostly sleeping money for all of them...

PritS said...

Ever tried to emjoy a rock show in staate of high. You wont find such geeks amusing then.

Boss, time is money (and ofcourse is charged heavily) so in a way both investment and visits to rock shows would follow a similar trend.

Vaise you can apply any science or economy principal to any thing in life. Its all the same thing looked from different angle.

suhas said...

Nice comparision .. you forgot to factor in one parallel in the rock concert. Foreign institutional Inverstors- the single largest factor that dictates which direction the markets would sway on a given day. If the audience form the small investor , who is the FII - the sponsors for the concert ?

satyajit said...

sucharita: i dont know abt UTI after its bust..most small investors got much low returns..and even then the govt. suffered a huge loss..

pj: c'mon thats a very casual statement to make..its absolutely convenient to say that any maxim is mirrored in life without analysing it..

suhas: well, i didnt include so many points..markets are huge things..u think of FIIs only in the Indian context..Think abt much stabler economies than India..whats the share of FII investment in them?

suhas said...

As Malcolm Gladwell puts it- No model is perfect and its effectiveness should be judjed by its ability to help the person reach a decision. I am not saying the
model won't work because there is no such thing as a perfect model that can be
used to predict things. I know that it is not in keeping with the motif of your post but this would make interesting read neverthless -
http://gladwell.typepad.com/gladwellcom/2006/11/index.html

Also Chk out his take on the whole Enron thing and the lack of information Vs Inundation of information angle
http://www.gladwell.com/2007/2007_01_08_a_secrets.html

satyajit said...

suhas: if any problem of consequence can be entirely explained in any single work, like a book, much less a post, then there's something wrong with the theory..to cover all aspects requires different viewpoints..

its fun to analyze things and try to make sense of it yourself without just accepting whatever you read..thats why i attempted this..

i'll visit those links for sure..thanks

Kuniko said...

Good post.