Irrationality By: Gabriel PotterMBA, AIFA® 2014.01.21

If you started learning about economics in school, as I did, in school, then you might have a tendency to believe in a clean theoretical version of economic activity.  You might visualize tidy graphs of supply and demand, with perfectly defined intersections of efficiency, sections of the graph cordoned off to represent supplier utility, purchaser utility, or dead-weight loss.  You might believe in the soundness of modern portfolio theory, perfect transparency, and – above all – rationality in decision making.

Of course, human behavior is not always rational.  Real world behavior diverges from rational behavior with alarming frequency.

If you ever needed proof that the markets are not rational, let me point out this article from Steven Perlberg at Business Insider.

In short, there were two companies with similar names – “Nest” and “Nestor” – which had nothing to do with each other.  One company – Nest – was benefitting from an acquisition deal from Google and the other company’s price shot up 1900%.  Were that many investors confused by the names that they bought the wrong company?.  More cynically, Nestor’s price may have shot up 19-times because savvy investors were counting on mistakes from confused investors.

In a rational world, this simply shouldn’t happen.  But how boring would that world be?

 

Gabriel Potter

Gabriel is a Senior Investment Research Associate at Westminster Consulting, where he is responsible for designing strategic asset allocations and conducts proprietary market research.

An avid writer, Gabriel manages the firm’s blog and has been published in the Journal of Compensation and Benefits,...

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