Keynesian Experiment: The Explanation

[philmophlegm]

OK, time for an explanation, especially as someone got all four correct answers.

The experiment you have been participating in is what is known as a 'Keynesian Beauty Contest'. Keynes first described it in his 'General Theory of Employment, Interest and Money'. The point of the beauty contest is that it explains movements in share prices.

Comments

[pellegrina]

Hm. My immediate reaction to your first poll was "there is clearly information I don't have since most beautiful is not the same as thought most beautiful by philmophlegm's flist is not the same as thought to be thought most beautiful by philmophlegm's flist - so I am probably being played by people i.e. philmophlegm who knows more about how the system is rigged - therefore don't touch", so I didn't take part in the poll and possibly fast-forwarded to your advice. However, this extreme aversive response to the faintest whiff of underinformed speculation means I will probably never invest in anything, and end up in poverty, since my standards for informed speculation would require me to quit my job for a full time study of the market before I started; I am too poor anyway for a suitably informed financial advisor even if I could make myself trust one.

[philmophlegm]

The strong form of the Efficient Markets Hypothesis would imply that there really is no point in hiring a financial adviser to pick shares since the share price already takes into account all possible information about the company.

Regardless of what you may or may not think about the EMH, you have to question whether advisers and fund managers add enough value from the investor's point of view. Some fund managers will outperform the market and some will underperform the market. On average they will equal the market performance - but they'll charge you money to manage your investment. _On average_ you would do better by investing your money in a simple tracker that matches the market but charges you less than a managed fund would.

So, from an investments point of view, unless you know enough to either beat the market or identify which fund managers can beat the market (and depending upon how strong the EMH actually is, neither of these may be possible). you're better off with a simple tracker.

[jane_somebody]

"you're better off with a simple tracker." - that's good to hear, since nearly all our investments (such as they are/were) have been of that nature. (Just don't mention the endowment mortgage...)

As for your advice, "Learn to spot a speculative bubble and don't invest in it." Good advice I'm sure, but depending on what kind of investor you are, mightn't even better advice be: "learn to spot a speculative bubble, how to invest in it early on, and when to sell up to maximise your gains"? Not that my nerves could take that sort of thing, but presumably this is what some traders do?

[philmophlegm]

Regrettably a small part of our mortgage is also endowment (thankfully only a small part). Even more regrettably the endowment bit is with Equitable Life...

You make a good point about bubbles and traders. Many traders not only look for bubbles but also both deliberately and accidentally feed them. They talk the bubble up for example. A serious issue for the people who set salaries and bonuses in City institutions is 'How do you tell if the really successful trader is getting good rewards mainly because he's in a high risk bubble rather than because he is good at spotting good stocks?"

And of course, lots of traders get burned when the bubble pops (or more accurately, the owners of the funds they are working for get burned). I think my advice remains, as far as amateurs go - steer clear of bubbles.

[kargicq]

Oh, I have to say the prize is a swizz! Nice interactive demo though. Can see that forming a part of a memorable economics lecture, esp. in these days of interactive lectures where the audience can vote with handsets. - Neuromancer

[philmophlegm]

Yeah, but to make the experiment work, I had to at least pretend it was a good prize.

Maybe the second lesson to be learned is not to trust economists...

[king_of_wrong]

Very interesting, as always :)

I'm not seeing the distinction between 'weak' and 'semi-strong' EMH, though... information always has a propagation delay, even if it's just the light cone, so how is "instantly" defined?

[philmophlegm]

It's just that - instant. You'd say that there is always a propagation delay, but the strong form of the hypothesis says that there isn't.

There is very strong empirical evidence that financial markets are not strongly efficient. It might be better to think of it as a hypothetical model.

[king_of_wrong]

The weak and the strong forms I have no problem with, just the semi-strong one... it annoys my inner physicist as it seems to imply time travel.

I realise it probably makes the maths much simpler, and I can certainly believe that the propagation delay is only a fraction of a second, but...

[philmophlegm]

I suppose the logic of the semi-strong (and I'm not saying that I believe the semi-strong EMH) is that many markets are supposedly so efficient nowadays that information does propagate phenomenally quickly. As soon as someone offers to pay over the odds for a share, everyone selling that share _instantly_ thinks "Hang on, if he's willing to pay more, it must be worth more" so the price _instantly_ rises.