Keynesian beauty contest

KEYNESIAN BEAUTY

CONTESTBy: Shih, Edbert

Siy, Madeleine

BACKGROUND

• Developed by John Maynard Keynes in 1936• Entrants to choose a set of six faces from 100 photographs• Everyone who picked most popular face was entered raffled

for a prize• Strategy was to pick not who you think is prettiest, but to pick

you think others will find prettiest

ANALOGIES

• Entrants= investors• Faces= stocks of companies• Raffle for Prizes= Chance to earn money

STOCK MARKET • Investors care about what other investors will buy in the

future. Here you often pay more a firm is worth, because you think that somebody else will pay even more later on.

• This strategy is sometimes called the” greater-fool theory,” because even though you’re a fool to pay to as much as you did, you’re betting that there’s a greater fool just down the road. And if you’re right, then of course you aren’t being foolish.

* Sometimes prices rises because people expect them to rise.

ECONOMIC CONCEPT

• Much of investment is driven by expectations of other investors rather than expectations about the fundamental profitability

• Potential investors ignore fundamental value (expected profitability based on expected revenues and costs), instead investors try to predict what the market would do

• Mostly evident in stock markets

RESULTS BASED ON CONCEPT

1. Investment is extremely volatile because fundamental value becomes irrelevant.

2. Most successful investors are either lucky or masters at understanding mob psychology.

3. Explanation for phenomena of stock market bubbles

SOURCES

• http://www.nytimes.com/2011/09/04/business/economy/on-wall-st-a-keynesian-beauty-contest.html?_r=0

• http://www.economicsnetwork.ac.uk/sites/default/files/Ashley/6%20References%20for%20KBC.pdf