Volatility, Efficient Markets and Human Behavior

In an earlier post, I quoted testimony given May 20 before a subcommittee of the Senate Committee on Banking, Housing and Urban Affairs about the “flash crash” rapid market drop of May 6. There  Larry Liebowitz, Chief Operating Officer of NYSE Euronext argued that with modern technology “fear gets transferred to the market faster than ever.”  Is that the market being super efficient? Not really. Fear is an emotion, a human behavior, not information about the underlying investments.

Behavioral Economics has spent the last two and a half decades gaining attention, at the expense it seems of its  predecessor Efficient Markets Theory.  So it shouldn’t be strange perhaps to hear a regulator speak in its terms.

Here’s an interesting chart compiled by Yale professor Robert J. Shiller:

This chart tracks word counts using the Lexis Nexis news data base of the terms “behavioral finance” and “efficient markets” by year in General News, Major Papers, Full Text, scaled by an estimate of the number of words of text on Lexis-Nexis for the year. Shiller calls it “dramatic evidence that behavioral finance has been gaining in the marketplace for ideas.”

Here’s the VIX volatility index, or “fear gauge” figures from the Chicago Board Options Exchange since 1990 when they changed the way they calculate the figures:

If markets are becoming more susceptible to emotion and even panic, does that change the way the individual invests? And how?

2 thoughts on “Volatility, Efficient Markets and Human Behavior

  1. geoffc1

    And, in the spirit of this blog, the idea that markets are not necessarily efficient has significant implications for long-term investors. Rob Arnott has pursued this theme with his ‘fundamental indexing’ concept, but this is only a start. In efficient markets, changes in the prices of assets reflect new information about underlying value. In real markets, changes in prices of assets can simply reflect panic.

  2. Karla

    I’ve been reaidng out several of your articles and i ought to say pretty excellent stuff. I will surely bookmark your site

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