Human Irrationality, Threat Perception and Coronavirus Pandemic
As reflected in the reaction of Global Markets to Corona Virus’ threat to global economy, it is easy to see why sentiment is often much more powerful than facts alone. This is not just limited to markets however. Events which appeal to human emotions and our primitive instincts always have a disproportionate impact than what objective assessment would warrant. This is true for terrorist threats, fears of recession and how broad based the impact of negative events will in general be.
Over the years, many philosophers, psychologists, authors and scientists have spoken about this phenomenon where the impact of news flow of certain events immediately triggers a ‘survival reaction’ or ‘fight or flight’ response, or in market parlance, ‘greed or fear’ taking over rational investment decisions. In many of these areas, one of the most elegant explanations and lucid examples backed by years of research and experiments with large sample size have come from Daniel Kahneman.
In his book ‘Thinking, Fast and Slow’, Nobel laureate Kahneman has spoken at length about ‘Human Irrationality’ and the way the process of thinking gets influenced by quite unexpected factors. For example, when asked about ‘how much is the population of Romania’ or ‘what is the distance between Mars and Earth’, the answer gets influenced by the numbers you may have encountered immediately before you reply – if they were big or if they were small, it doesn’t matter if they were in an altogether different context. Of course, the assumption here is that one doesn’t know the exact answer and is making a guess.
“Thinking, Fast and Slow” is a very interesting book and, at the same time, full of surprises and full of results which one least expects and which go against conventional thinking. One of the biggest lessons from this book is at least an awareness of how much we think we know, but in reality, we don’t. The false sense of confidence we have about many of our ideas and our understanding keeps us away from actually questioning those assumptions.
There are many cognitive biases and many of them contribute to making markets inherently not rational is the classic efficient markets sense. Whether we call it sentiment or something else, it is the underlying basis for overreactions which we usually see in the markets. No doubt Corona Virus is a serious health issue for the global economy. But there is hardly any doubt that the fear of Corona Virus and continuous media coverage can lead to fear and panic and a more severe reaction than is actually warranted. But then who cares for survival rates and transmission rates when the only thing everyone is talking about is how many more countries found their first case and the number of new cases that have surfaced in already affected countries.
As of now, news flow and sentiment are more driven by big picture and less by the actual probability of an individual getting affected. It is hard to tell how long such overreaction will persist. Let us wait and watch because humans can be more irrational than can be discounted in financial models for the markets and, more importantly, they collectively can remain irrational for a long time.
EM Alpha LLC
For more EMAlphainsights on Emerging Markets, please visit https://emalpha.com/insights/. To know how you can use EMAlpha’s unstructured data on Emerging Markets for better investment decisions, please send us an email at [email protected].
EMAlpha, a data analytics and investment management firm focused on making Emerging Markets (EMs) accessible to global investors and unlocking EM investing using machines. EMAlpha’s focus is on Unstructured Data as the EMs are particularly susceptible to swings in news flow driven investor sentiment. We use thoroughly researched machine learning tools to track evolving sentiment specifically towards EMs and EMAlpha pays special attention to the timely measurement of news sentiment for investors as these markets can be finicky and sentiment can be capricious.Our team members have deep expertise in research and trading in multiple Emerging Markets and EMAlpha’s collaborative approach to combining machine learning tools with a fundamental approach help us understand these markets better.
This insight article is provided for informational purposes only. The information included in this article should not be used as the sole basis for making a decision as to whether or not to invest in any particular security. In making an investment decision, you must rely on your own examination of the securities and the terms of the offering. You should not construe the contents of these materials as legal, tax, investment or other advice, or a recommendation to purchase or sell any particular security. The information included in this article is based upon information reasonably available to EMAlpha as of the date noted herein. Furthermore, the information included in this site has been obtained from sources that EMAlpha believes to be reliable; however, these sources cannot be guaranteed as to their accuracy or completeness. Information contained in this insight article does not purport to be complete, nor does EMAlpha undertake any duty to update the information set forth herein. No representation, warranty or undertaking, express or implied, is given as to the accuracy or completeness of the information contained herein, by EMAlpha, its members, partners or employees, and no liability is accepted by such persons for the accuracy or completeness of any such information. This article contains certain “forward-looking statements,” which may be identified by the use of such words as “believe,” “expect,” “anticipate,” “should,” “planned,” “estimated,” “potential,” “outlook,” “forecast,” “plan” and other similar terms. Examples of forward-looking statements include, but are not limited to, estimates with respect to financial condition, results of operations, and success or lack of success of certain investment strategy. All are subject to various factors, including, but not limited to, general and local economic conditions, changing levels of competition within certain industries and markets, changes in interest rates, changes in legislation or regulation, and other economic, competitive, governmental, regulatory and technological factors affecting the operations of the companies identified herein, any or all of which could cause actual results to differ materially from projected results.