The Hindu Business Line : Can't drive markets or racecars in straight line

YOU normally don't expect saints at a discotheque, nor mathematicians in the market, but that was what happened when John Allen Paulos fell `disastrously in love' with the market. He was good in statistics, probability and psychology, but his favourite WorldCom crumbled like the ninepins. Like most men, he kept buying even as prices dived deep, kept his wife in the dark about his investment, and reworked his math logic to convince himself "that everything would be all right".

His story of gamble is out from Penguin: A Mathematician Plays the Market — a tale of `greed, hysteria, business gurus and gullible punters'. A few snatches:

As with beautiful people and, for that matter, distinguished universities, emotions and psychology are imponderable factors in the market's jumpy variability. Just as beauty and academic quality don't change as rapidly as ad hoc lists and magazine rankings do, so, it seems, the fundamentals of companies don't change as quickly as our mercurial reactions to news about them do.

It may be useful to imagine the market as a fine racecar whose exquisitely sensitive steering wheel makes it impossible to drive in a straight line. Tiny bumps in our path cause us to swerve wildly, and we zigzag from fear to greed and back again, from unreasonable gloom to irrational exuberance and back.

Precision and objectivity of bookkeeping fit uncomfortably alongside the vagueness and subjectivity of many of the profession's practices. Transparency, trust, independence, and authority are all needed to make the accounting system work. They are all in great demand, but sometimes in short supply.

John Maynard Keynes wrote: "Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back."

A corollary of this is that fund managers and stock gurus, who slickly dispense their investment ideas and advice, generally derive them from a previous generation's Nobel prize-winning finance professor.

Outperforming the market requires that one remain on the cusp of our collective complexity horizon. It requires faster machines, better data, improved models, and the smarter use of mathematical tools, from conventional statistics to neural nets. If this is possible for anyone or any group to achieve, it is not likely to remain so for long.

You might compare beta to different people's emotional reactivity and expressiveness. A zero beta person would have to be unconscious, perhaps from ingesting too many beta-blockers. Betas may vary with the type of stimulus a company faces.

Fundamentals are to investing what marriage is to romance or what vegetables are to eating — healthful, but not always exciting.

Some understanding of them, however, is essential for any investor and, to an extent, for any intelligent citizen.

Markets are, perhaps, like politics. Anybody can play the game.

(Book courtesy: Landmark)

BookValue@TheHindu.co.in

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