Reality TV disproves the efficient market hypothesis - The Share Centre Blog

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Michael Baxter

Reality TV disproves the efficient market hypothesis

Written by: Michael Baxter on December 27th 2013

Category: Thought for the day

The markets are always right. The markets factor in everything that is known when valuing a stock, therefore you can’t win. Err, well here is an explanation as to why that is wrong, and it draws upon the final of TV’s ‘Strictly Come Dancing’.

The idea of the efficient market hypothesis draws upon a little experiment carried out more than a hundred years ago by Francis Galton. He was visiting a fair, where a game to guess the weight of a butchered ox. To Galton’s surprise, he found the mean average guess was almost precisely right. And so from that we get the idea of the wisdom of crowds.

What is clear, however, is that people are easily influenced. When we are in a group situation, crowd compliance sets in. We get the madness of crowds. Group psychology shows us that the crowd is not wise when each individual in that crowd knows what everyone else is doing.

I think that in this post global finance crisis age, we can say that the idea of groupthink getting in the way of the wisdom of the crowds is pretty obvious.

So the idea moves on; now they say the crowd is wise when each individual acts in isolation.

But I want to make another point. It seems to me that people can be surprisingly similar. We often react in similar ways to similar circumstances. And sometimes we all, or most of anyway, draw the same wrong conclusion from the same evidence.

Psychologists already know, for example, that if you are trying to estimate a number – say the value of a house or the future value of the FTSE 100 or the weight of an ox – and just before you make your estimate you happen to see another number, a completely unrelated number, your estimate is influenced. Try it. Ask two people how much they think your home is worth, But before the second person answers, say to them: Did you know the tallest person in the world is 20 foot tall? All things being equal the second person should give a higher estimate of the value of your home.

Now let me turn to reality TV. I am told that the winner of this year’s ‘Strictly Come Dancing’ was Abbey Clancy. I am told she was very good, but that Natalie Gumede, the person who came joint second, was supremely talented, and possibly the one of the best contestants the programme has ever had.

So why didn’t she win? I can think of two reasons: the first relates to the fact she played a baddie in ‘Coronation Street’, and other may relate to the colour of her skin.

Now I am not saying that the Brits are any more racist than anyone else. And maybe it is not racist to vote for someone who looks closer to your cultural identity. But when it comes to the opinions of crowds, small irrational preferences can play a role.

Personally, I think it is a national scandal that Mo Farah did not do better in either this year’s or last year’s BBC sports personality of the year. I am sure that if his name had been Brendan Foster, or Sebastian Coe, he would have done better. I am not saying either Bradley Wiggins or Andy Murray did not deserve their victories. But I am saying, certain pre-conceived notions influence the views of the crowd, even when each member was voting in isolation.

And that is why I think people with more unusual ideas, more individualistic thinkers if you like, can beat the markets.

These views and comments are those of the author alone and do not necessarily reflect the view of The Share Centre, its officers and employees

Tags: crowd compliance, efficient-market hypothesis, Francis Galton, Group psychology, groupthink, madness of crowds, wisdom of the crowds

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