Stock market keynesianism
A Keynesian beauty contest is a concept developed by John Maynard Keynes and introduced in Chapter 12 of his work, The General Theory of Employment, Interest and Money , to explain price fluctuations in equity markets.
John Maynard Keynes 'a great economist but poor currency trader' | Business | The Guardian
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 the six most attractive faces from a hundred photographs. Those who picked the most popular faces are then eligible for a prize.
A naive strategy would be to choose the face that, in the opinion of the entrant, is the most handsome. A more sophisticated contest entrant, wishing to maximize the chances of winning a prize, would think about what the majority perception of attractive is, and then make a selection based on some inference from his 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.
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.
John Maynard Keynes - Keynes The Money Manager
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 to be.
National Public Radio 's Planet Money tested the theory by having its listeners select the cutest of three animal videos.
The listeners were broken into two groups. One selected the animal they thought was cutest, and the other selected the one they thought most participants would think was the cutest. The results showed significant differences between the groups.
Fifty percent of the first group selected a video with a kitten, compared to seventy-six percent of the second selecting the same video.
What Keynes can teach us about investing - MarketWatch
Individuals in the second group were generally able to disregard their own preferences and accurately make a decision based on the expected preferences of others. The results were considered to be consistent with Keynes' theory.
Other, more explicit scenarios help to convey the notion of the contest as a convergence to Nash Equilibrium.
For instance in the p -beauty contest game Moulin , all participants are asked to simultaneously pick a number between 0 and In play of the p-beauty contest game where p differs from 1 , players exhibit distinct, boundedly rational levels of reasoning as first documented in an experimental test by Nagel The lowest, 'Level 0' players, choose numbers randomly from the interval [0,].
The next higher, 'Level 1' players believe that all other players are Level 0. These Level 1 players therefore reason that the average of all numbers submitted should be around Similarly, the next higher 'Level 3' players play a best response to the play of Level 2 players and so on.
The Nash equilibrium of this game, where all players choose the number 0, is thus associated with an infinite level of reasoning. Empirically, in a single play of the game, the typical finding is that most participants can be classified from their choice of numbers as members of the lowest Level types 0, 1, 2 or 3, in line with Keynes' observation.
In another variation of reasoning towards the beauty contest, the players may begin to judge contestants based on the most distinguishable unique property found scarcely clustered in the group. As an analogy, imagine the contest where the player is instructed to choose the most attractive six faces out of a set of hundred faces.
Under special circumstances, the player may ignore all judgment-based instructions in a search for the six most unusual faces interchanging concepts of high demand and low supply. Ironic to the situation, if the player finds it much easier to find a consensus solution for judging the six ugliest contestants, she may apply this property instead of attractiveness level in choosing six faces. In this line of reasoning, the player is looking for other players overlooking the instructions which can often be based on random selection to a transformed set of instructions only elite players would solicit, giving them an advantage.
As an example, imagine a contest where contestants are asked to pick the two best numbers in the list: All judgment based instructions can likely be ignored since by consensus two of the numbers do not belong in the set.
This contest has been held in Spektrum der Wissenschaft, November , with results as PDF. Both links in German; Google translation. See Nagel et al. From Wikipedia, the free encyclopedia.
A Stock Market Experiment".
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