Some context; the assignment is about Robert Shillers lecture at yale here and how it applies to the volatility we've seen in the market.
Shillers’
lecture on behavioral finance began with a somewhat known but unknown
revelation that what humans really seek is being praised, but not just that, we
seek to be worthy of their praise.
Although he didn’t say it in this lecture, I think this idea applies to the
financial industry because taken it prima
facie one could make the case that the returns fund managers earn is
irrelevant. What managers (and all of us) really want, is for us to be infamous
for timing the market, seeing things others can’t, and accomplishing
extraordinary things that only others could dream of. If we link this to the
another claim Shiller made from Khaneman and Tsevarsky’s Prospect Theory, that
losses of one degree are “felt” more strongly than gains of the same degree, I
would make the claim that the market volatility that has been experienced the
last 2 weeks is due to the ego that the agents within the financial
institutions hold and the expectations they believe their clients may have of
them. No financial manager wants to be the one that to ride the market all the
way to the bottom, even if they believe that the rapid decrease in value from
equity markets is far from the true fundamental value they can realistically
imagine that their clients will look at the short-term
loss in value and immediately blame the manager. There would be capital calls,
news reports, and social stigma from the investment community, because no one
wants to be affiliated with them. This imagination would cause funds to sell a
portion of their liquid assets; because these funds have huge capital holdings
this causes massive drops in indexes. This creates a vicious cycle where the
investors will continue to sell because they see everyone else is continuing to
sell. In some cases they may completely forget about looking for value, and
instead focus on avoiding the loss of value.
One
could also make the claim that the volatility we see may be due to a lack of
liquidity from market participants. The evidence being that market participants
are “anchored” to a specific price that they want to sell at. Thaler writes in
his book that most humans want to at least break even and will anchor
themselves to the price they bought it at. This lack of volume decreases the
number of buyers or sellers in a marketplace and results in the seller reducing
their ask price to pay for the buyers liquidity premium.
