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Wednesday, March 21, 2012

Got Rationality?

All current  financial models are based on the proposition that man will make a mathematically rational choices when trading or investing.

This absurd notion goes against everything we know about the history of man.  Other than that, Daniel Kahneman devised a series of experiments that proved beyond any clinical doubt that man's rationality is skewed in some very predictable ways:

A) Man is very risk averse to the point of extreme mathematical irrationality when trading and investing.

B) Man is extremely attached to the comfort of the familiar when trading and investing.  He is willing to give up great mathematical utility to preserve things and situations that are familiar and comfortable.

C) Man has a very short term view when investing and trading that causes him to miss the obvious utility of an opportunity that will mature over a longer horizon.

When taken together it is easy to see how politicians and their constituent partisans can argue endlessly and fervently over meaningless minutiae while the country sinks into an oblivion of debt.

It is easy to see how short term data can be used to give the illusion of comfort that things are getting better.

It is easy to see how people cling to their stocks, bonds and US dollars, when all of these things have persistently lost inflation adjusted value over the last 20 years.

And it is easy to see how most traders/investors still fail to see the value of gold over time, in spite of the fact that it is the only investment vehicle extant that remains in a long term bull market.

And finally, it is easy to see how most everyone will be taken by surprise when the next external shock sends the financial system over the brink. 

Got rationality?  Got Gold?

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