Why Markets Make Mistakes
Via Simoleon Sense:
Introduction (Via SSRN):
The research described in this article calls into question the assumptions of rationality, transparency, efficiency, and homogeneity on which many models of markets are based (see for example Samuelson 1948; Bass 1969; Fisher and Pry 1971, Malkiel 1973). The classic models assume, at least implicitly, that decision makers understand the structure of the market and how it produces the dynamics which can be observed or might potentially occur. Are these models acceptable simplifications, or can they be seriously misleading?
This article explains why markets routinely and repeatedly make “mistakes” that are inconsistent with the simplifying assumptions and often produce disastrously wrong business decisions. The undesirable outcomes could include vicious cycles of investment and profitability, market bubbles, accelerated commoditization, excessive investment in dead-end technologies, giving up on a product that becomes a huge success, waiting too long to reinvent legacy companies, and changes in market leadership. The article illuminates the effects of bounded rationality, imperfect information, fragmentation of decision making, and extrapolating past trends.
capital-markets, EMH, models |
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