The Madness of Markets (Alex Edmans)

Alex Edmans (0:00)

After a country is knocked out of the World Cup, the market falls by about a half a percent the next day.

Benjamin Felix (0:06)

Makes you really think that people are just not well equipped to make important financial decisions.

Alex Edmans (0:11)

Sometimes you don't need unique information, all you need is patience and a longer horizon.

Benjamin Felix (0:21)

Welcome to episode 431 of The Rational Reminder Podcast. I'm Ben Felix, Chief Investment Officer at PWL Capital.

Cameron Passmore (0:28)

I'm Cameron Passmore, Chief Executive Officer at PWL Capital.

Benjamin Felix (0:32)

Today, we are joined by Alex Edmans, Professor of Finance at London Business School, who has previously appeared on this podcast in episodes 192 and 361

Cameron Passmore (0:42)

In addition to being such a great guest, Alex is also the author of the books, Grow the Pie, May Contain Lies, and his new book, The Madness of Markets came out last month.

Benjamin Felix (0:56)

In this conversation, we talk about why a football loss can sink a nation's stock market, why identical assets can trade at different prices, and the habits that help investors avoid the common mistakes that many of us make. Stick around to the end to hear our thoughts on the conversation. But for now, let's go ahead to our talk with Alex.

Alex Edmans, welcome back to The Rational Reminder Podcast.

Alex Edmans (1:21)

Thanks so much, Ben. It's great to be back.

Benjamin Felix (1:23)

Glad to have you back. We've got a new book out. You write a lot of books. I gotta say, that's quite impressive.

Alex Edmans (1:28)

Well, there's lots of exciting research, not just by me, but by lots of other people that I love to make this accessible to a general audience. So it's a huge pleasure and a lot of fun to write them.

Benjamin Felix (1:38)

Love it. Yeah, and you do. You make the research and the information very accessible, which is really cool to see.

Alex, how can a football game's outcome affect a nation's stock market?

Alex Edmans (1:49)

This is a great question because it should not. So what you learn in any finance class is that the market is affected by fundamentals. So what should affect a stock price is dividends and profits and sales growth. But what research actually finds is that sentiment and emotions make a difference. And so this is why I chose to look at the effect of football or soccer results, is that this is something which affects investor mood. And so what my co-authors and I found is that if you study over 1000 soccer games after a country is knocked out of the World Cup, the market falls by about a half a percent the next day, which is 15 billion pounds when applied to the UK stock market. And this is because of the effect that it has on your emotions. Now some listeners might think, yeah, my mood is affected by my emotions, but I'm a professional, so when I go and trade, I will put my game face on, I will block out my emotions and I will get back to rationality. But what this research suggests is that's not possible. You are human, and if you're a human, then you are susceptible to your emotions and something like this does affect how you trade or maybe how you assess a company.

Cameron Passmore (2:57)

Can you talk about some other unlikely things that seem to move the market?

Alex Edmans (3:01)

Absolutely. Weather also affects the market.

Again, you might think, okay, weather will affect me if I'm on holiday or if I'm a farmer when I'm working outside. But actually, this was a study which was done not only in the US but around the world, is that if it was sunnier than expected for that time of the year, then the market was more positive, and when it was cloudier, the market went down. So a lot of these external factors, what I call them external, is there should not really be any effect on profits and dividends, unless weather becomes extreme, such as a floor or really sunny conditions, this shouldn't have any effect on productivity, but it does have an effect on your emotions.

Benjamin Felix (3:40)

I've got a statistical question. When this stuff is studied, how do we know that it's an actual effect versus just a statistical anomaly?

Alex Edmans (3:48)

This is really important. You might worry that this is spurious correlation or even worse, data mining. So what is spurious correlation? It's something which just happens to be a chance pattern in the data.

Data mining is if researchers go and fish for spurious correlations because you want to find something significant, because then you can publish a paper around it. And you might think, well, maybe the weather people looked at loads of measures of weather. They could look at temperature and rainfall and snowfall and cloud cover. But what was interesting is that the people who wrote this paper, they started with an existing paper which looked at just the US, and they expanded it to 20, 30 countries around the world. So they made sure that it held out of sample. And similarly for my football paper, we didn't just look at football, we looked at other international sports such as cricket and rugby and basketball. So the robustness of the finding is really important. And this contrast with some findings in social science where they were not found to be robust. For example, I think the second most viewed TED talk of all time by Amy Cuddy is on the effect of power poses. If you stand with your arms aloft in a victory salute, then this apparently improves your public speaking and interview performance. But that was not replicated in other settings. So I think replication is important. Another thing is just basic common sense. So does it make sense for football to affect the stock market? And this is why I wrote the paper because I saw the weather papers.