Archive for October 16th, 2011

October 16, 2011

Keynesian Beauty Contest

beauty by richard borge

A Keynesian beauty contest [keyn-zee-uhn] is a concept developed by economist John Maynard Keynes in 1936 to explain price fluctuations in equity markets. Keynes described the action of rational agents in a market using an analogy based on a fictional newspaper contest, in which entrants are asked to choose a set of six faces from photographs of women that are the ‘most beautiful.’ Those who picked the most popular face are then eligible for a prize. A naive strategy would be to choose the six faces that, in the opinion of the entrant, are the most beautiful. A more sophisticated contest entrant, wishing to maximize the chances of winning a prize, would think about what the majority perception of beauty is, and then make a selection based on some inference from their knowledge of public perceptions. This can be carried one step further to take into account the fact that other entrants would each have their own opinion of what public perceptions are. Thus the strategy can be extended to the next order, and the next, and so on, at each level attempting to predict the eventual outcome of the process based on the reasoning of other rational agents.

‘It is not a case of choosing those [faces] that, to the best of one’s judgment, are really the prettiest, nor even those that average opinion genuinely thinks the prettiest. We have reached the third degree where we devote our intelligences to anticipating what average opinion expects the average opinion to be. And there are some, I believe, who practice the fourth, fifth and higher degrees.’ Keynes believed that similar behavior was at work within the stock market. This would have people pricing shares not based on what they think their fundamental value is, but rather on what they think everyone else thinks their value is, or what everybody else would predict the average assessment of value is.

October 16, 2011

Thomas Theorem

The Thomas theorem is a theory of sociology which was formulated in 1928 by W. I. Thomas (1863–1947): ‘If men define situations as real, they are real in their consequences.’ In other words, the interpretation of a situation causes the action. This interpretation is not objective. Actions are affected by subjective perceptions of situations. Whether there even is an objectively correct interpretation is not important for the purposes of helping guide individuals’ behavior. In 1923, Thomas stated more precisely that any definition of a situation will influence the present. Not only that, but—after a series of definitions in which an individual is involved—such a definition also ‘gradually [influences] a whole life-policy and the personality of the individual himself.’ Consequently, Thomas stressed societal problems such as intimacy, family, or education as fundamental to the role of the situation when detecting a social world ‘in which subjective impressions can be projected on to life and thereby become real to projectors.’

The 1973 oil crisis resulted in the so-called ‘toilet paper panic.’ The rumor of an expected shortage of toilet paper—resulting from a decline in the importation of oil—caused people to stockpile supplies of toilet paper and this caused a shortage. This shortage, seeming to validate the rumor, is also an example of a self-fulfilling prophecy. The Beauty Contest Theory, developed by John Maynard Keynes, justifies why the price of a share of stock does not necessarily develop according to rational expectations. He acts on the assumption that many investors make their decisions not according to their own computations of an asset’s worth but by predicting the conclusions of other market participants.

October 16, 2011

Tinkerbell Effect

tinkerbell

The Tinkerbell effect is a term describing things that are thought to exist only because people believe in them. The effect is named for Tinker Bell, the fairy in the play Peter Pan who is revived from near death by the belief of the audience.

Claimed cases include: private property; the value of a nation’s money in a fiat system; the value of gold; civil society; and the ‘rule of law.’