Mind Over Money Essay Example

The video documentary, Mind Over Money, by NOVA seeks to explore how human emotions or rationale play a critical role in influencing and determining markets. One major question that arises is whether human decisions are precisely calculated or are purely based on emotions when it comes to money. Various experiments have pointed to the conclusion that our decisions are irrational.

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First, the experiments done by the students at the University of Chicago on the capital valuation of a wine bottle and bidding of a twenty dollar bill indicates the power of emotions on individual's willingness to spend on specific objects. In the $ 20 bill scenario, irrationality was driven by competition. On the other hand, the social security number of the students influenced price determination during valuation of the wine bottle. In the New York street experiment where shoppers were asked whether they would consider taking $100 or $ 101 a year and a day later, everyone chooses the latter. However, when asked whether they would take $100 that day or $101 the next day, they all went for the money that day. Ideally, the logic behind these two scenarios reaffirms the argument that our minds cannot be rational when money is involved.

Furthermore, the documentary also examines the financial bubbles that have hit the world over the past decades. Robert Shiller, an economist, argues that human emotions, particularly envy play a major role in creating financial bubbles. He observes that prices balloon when individuals get jealous of their counterparts who earn more in a week that their yearly income. Before, people doubted that wealth could be generated so quickly and so easily. All over sudden, people have started competing against each other rendering acquisition of wealth nearly instantaneous. Economic bubbles have been occurring for many years and can be dated back to 1637 following the collapse of the tulip market in Holland. The most recent and famous economic bubble was the 20th Century Great Depression caused by the stock market crisis and the most recent 2007-2008 housing crisis.

Traditional economic models hold the assumption that individuals make rational decisions. This paradigm states that behind every transaction and purchases people make, they have a pre-calculated justification for their actions. Shiller and many other behavioural scientists dispute such claims. Shiller argues that the market crisis is the product of human behaviour. However, rational economists argue that our moods are not sufficient enough for a good explanation. They rely on an analytical technique known as Efficient Market Analysis ( EMA) which is based on the assumption that markets are controlled by derivatives that alleviate risks and mathematical calculations that asses potential risks.

Towards the end of the video, the recent housing crisis and the concept of EMA are critically analyzed. The housing crisis indicates that whatever instruments that financial analysts have been using to secure their investments contribute to the problem. Eventually, the numerous assumptions regarding the housing crisis according to EMA show the correct prediction of the market without any economic model.

Rationality of markets

The theory of market efficiency suggests that markets are rational and stocks trade at their fair values. This makes it difficult for people to purchase or sell depreciated stocks for inflated prices. The irrationality of humans is the reason as to why it is impossible to outperform the markets through stock timing. The only way willing investors can gain high returns is by taking risky investments. While a large volume of evidence supports the Efficiency Market Hypothesis numerous facts from academicians dispute it.

The basic argument behind EMH is that humans cannot beat the markets because they can neither be inflated nor undervalued (Degutis, Augustas, and Lina Novickyte). For instance, whether shares go up or down it is purely based on the unknown information. In other words, market prices are not affected by past or present activities. For markets to be efficient certain criteria must be met. First, critical information must be made available and accessible within the markets. Secondly, investors must act rationally. In the real world, it is impossible to ensure such conditions.

Behavioral bias is deeply ingrained in human nature. Therefore, to assume that investors will not be prone to any biases is an illusion of the mind. Critics of EMH argue that financial bubbles and subsequent crashes indicate that market pricing varies by a fair distance. Rational markets only exist in an idealistic world.

Information indicating a potential crash might be there, but not accessible to the markets. If such information could be available financial bubbles would not happen in the first place. If consistency and accuracy in predicting the stock markets are impossible, therefore it is unimaginable to try and predict the market with unavailable information and irrational investors (Matteo).

Conclusion

Markets consist of a combination of investors and detailed information. At times markets usually have misinformation that is consequently affected by our behavior and error. Investors often lack complete information about the market and due to this; they end up relying on their emotions to affect prices of assets in the market. One major flaw of the Efficient Market Hypothesis is the assumption that all markets exhibit a fair value of stocks. Before prices are established traders must first capture the variations in pricing in order to accurately establish the current price.

Works Cited

Degutis, Augustas, and Lina Novickyte. "The efficient market hypothesis: a critical review of literature and methodology." Ekonomika 93.2 (2014).

Rossi, Matteo. "The efficient market hypothesis and calendar anomalies: a literature review." International Journal of Managerial and Financial Accounting 7.3-4 (2015): 285-296.