Markets and people

Charles Morris (in The Trillion Dollar Meltdown ) says that one of the dangerous trends emerging in the 80s and 90s, and lurking behind the current financial crisis, is the “increased dominance of investment decisions by mathematical constructs.” He admits that “Large securities portfolios usually do behave more or less as the mathematics suggests,” but warns that the math breaks down in crisis: “For shares truly to mirror gas molecules, trading would have to be costless, instantaneous, and continuous. In fact, it is lumpy, expensive, and intermittent. Trading is also driven by human choices that often make no sense in terms that models understand. Humans hate losing money more than they like making it. Humans are subject to fads. Even the most sophisticated traders exhibit herding behavior . . . . in real financial markets, air molecules have a disturbing knack for clumping on one side of the room.”