Faced with the prospect of writing about the problems in the eurozone and especially Greece and Spain – as I notice I was this time last year and the year before that – I am as ever grateful to the seemingly endless ability of behavioural fi nance to come up with ingenious explanations as to why most human beings should not be allowed within 100 miles of anything fi nancial
Imagine a friend calls you to say they have managed to score some tickets for the weekend’s big sporting event and you have fi rst refusal. Reasonably enough they would like to know your answer now but you are expecting to fi nd out tomorrow whether you have been successful in an interview for your dream job. Do you bite your friend’s hand off or wait till you hear if you have got the job? If you looked at it rationally, you would probably conclude you are off to the fi nal one way or the other – either to celebrate getting the job or to try and forget about missing out. Yet many people would put off taking their friend up on the ticket – in the process possibly even risking missing out on the match – until they knew the outcome of the job interview. And if they did so, they would be a victim of what behavioural scientists call the ‘disjunction eff ect’ – when a point of uncertainty prevents a decision between two choices even though those choices would most likely lead to the same result. Obviously there are one or two of these points of uncertainty in the world these days but there are no prizes for guessing which one we are going to pick as an illustration. I do not imagine you have too many Greek holdings in your portfolio at the moment but since we were hypothesising anyway, let’s keep going. Say you have picked up on a Greek company that looks incredibly cheap and, after you have carried out all your usual analysis, it still looks incredibly cheap. Do you buy it? After all, if Greece stays in the euro, you would just be taking the same risks you thought you were already so not much has changed. On the other hand, if Greece leaves the euro, the company has so much upside that – even ignoring any added competitiveness that may result from the devalued ‘New Drachma’ – the chances all that value is lost seem negligible. Either way, you might rationally conclude that you should buy and yet the uncertainty can have a paralysing eff ect. Not being in possession of certain facts can obviously represent a signifi cant bar to decision-making yet other unknowns can be less important than they fi rst appear. The lesson of the disjunction eff ect for investors – tough as it may admittedly be to put into practice – is to try and work out which choices are genuine points of uncertainty that must be carefully weighed up and which ones might really be no more than excuses for inaction in a scary world.
Comments