Behavioral finance and the science of voodoo

I just had some argument with a PhD researcher about the value of behavioral models over the up-till-now traditional financial modeling. You see, behavioral finance is a growing field of financial science and came into prominence after the last catastrophic implosion of the global financial market. Obviously some greedy folks went berserk and all the fancy market models developed to understand them were obviously on vacation (read Fama, French, Sharpe, Markowitz, Merton Miller and a bunch of others. I can’t even imagine that some people actually got a Nobel for this type of rubbish. In a world where Obama can get a Nobel for Peace in anticipation of peace, anything can happen!).

From the behavioral finance people’s point of view, financial and capital models are crap and can’t model how the financial world will behave as it is based on what is called the rational model (players will behave according to expectation) but can’t understand the primordial human instincts (greed, fear, ego, etc.) which ultimately always upturn things.

This is actual bone of contention. We both agreed that the current models are capital BS but I believe that the financial and capital behavior can be modeled. What we don’t have now is enough attributes to put into the model to factor things in. Another thing is to redefine what a rational attribute is. Purchasing an equity based on PE ratio is a rational behavior but it doesn’t even rank as much as buying because of fear! Or why would the experts spend so much time wondering that the Weekend Effect is all about?

This is what luxury good purveyors have known for centuries, people don’t buy because a purchase makes sense, they buy for all manners of reasons and that is what we modeler need to figure out.

Can fear be modeled? Yeah! Same for herd behavior, for greed, for revenge, etc. What I dont know is if a smart dude is going to figure it out in a year, decade or century but I can put my bet on 2 decades out there. What do you think we are going to use all those powerful computers to do? Turn them into Precogs while the world reenact Minority Report. So between now and then, I will advice my fancy research to go find another job; behavioral finance career is about to hit a dead end.

The economy of enforcement

Lagos is a mad place. Chaos incorporated. Although that isn’t enough to make me do the Andrew Method (run away) . Apart from security and electricity, traffic is the biggest problem we have. It takes X number of hours to move from point A to B. I know that LASTMA was created to solve this problem but they are more interested in shafting drivers than resolving the road logjam. But that is a story for another day or symposium like Abami Eda would say.

Another tangent to this post is that all tiers of government are broke, my dear Lagos inclusive. Fashola is rolling out tax laws faster than Usain Bolt could complete a 100m dash. That itself hasn’t worked well.

Talking about the traffic palaver, even though we have bad roads, 80% (don’t ask for the source of data!) of the gridlock is caused by bad drivers: Danfo drivers picking passengers; vehicles moving against traffic; impatient drivers not giving way at junctions, etc.

It came to me that government could augment its income with loads of law breakers roaming the street. I know LASTMA has gotten away with not doing much because government wasn’t expecting much from them. But say LASTMA has a target of catching 5,000 offenders a day with average fine of 10,000. That is some 50M per day and almost a billion in one month. Well, maybe that is an exaggeration but come on, if LASTMA can generate enough fines to pay for its officers, what is wrong with that? When people know that the cost of breaking a traffic offence is so much, they start behaving and then traffic is better and ultimately there is going to be need for fewer LASTMA officers.

Same crooked (smile) idea could be applied to building codes (those converted shops cause more evils that you can imagine) and to companies messing up the environment. Think of the glee of fining offices that block drainages with N100K or the premises get locked down. When it becomes so expensive to break the law, the government can spend less money unblocking those drainages.

And hopefully, they would have more money to pave the road and a smooth road makes it easier to escape LASTMA in case I get caught. Now, I think you get the point.