The Zeitgeist Investor Endnotes

General

1. There are lots and lots of references to various behavioural biases, spread throughout the book.  The evidence for these (and more) can be found in The Big List of Behavioral Biases.

Forward

1. The evidence for longevity comes from UK actuarial tables.  Other developed nations are following a similar pattern.
2.  The 6% trading tax we all suffer from is outlined by Pete Comley in Monkey With a Pin available free at http://monkeywithapin.com/

Markets Are Adaptive, People Are Reflexive

1. Wegener first published his theory in The Origins of Continents and Oceans, in 1915, to a universal chorus of disapproval.  The acceptance of continental drift had to wait until the 1950s.
2.  Semmelweis’ hand-washing techniques reduced mortality rates from about 20% to close to zero.  To compound the tragedy Semmelweis died, aged 47, in an asylum, of septicaemia.
3.  In response to Wegener’s ideas one of his opponents, R. Thomas Chamberlain, opined “If we are to believe in Wegener's hypothesis we must forget everything which has been learned in the past 70 years and start all over again”. Quite.
4. For the origins of the thermodynamic theory of economics see Exit the Walras, Followed by Equilibrium, charting Léon Walras’ madly determined attempts to make economics scientifically equivalent to physics.
5. Our problems with introspection are usually labelled as “the blind spot bias”.  This was discussed in Bamboozled by Your Blind Spot Bias, an article based on Emily Pronin, Matthew B. Kugler (2006), “Valuing thoughts, ignoring behavior: The introspection illusion as a source of the bias blind spot”.
6.  The relatively poor returns of US stocks against government bonds was discussed in Arnott: 40 years of Bonds Beating Equities, describing Rob Arnott’s research in this area.  The idea that an Italian investor may still be in the red after seven decades was described in Elliot Dimson’s Triumph of the Optimists: “Only when we look back at intervals of at least 75 years, as indicated by the right-hand arrowhead, can we say that the real return on Italian equities has been consistently positive.”

Anchored in the Wonder Years

1. The actual returns on stockmarkets are surprisingly difficult to figure out, partly due to problems with data and so-called survivorship bias, where corporations that fail drop out of the numbers.  4% seems to be about the average real return, although the US did better than this, and best of all economies. 1980-2000 averaged about 12.6%, 1990-2000 about 14.2%.  See, for example: Risk and Return  in the 20^th and 21^st Centuries by Elroy Dimson, Paul Marsh and Mike Staunton.
2. As with all this data the actual point at which the markets regained their 1929 highs is difficult to figure out, but somewhere around 1950 is about right taking inflation into account.
3. The meme that you need to reinvest dividends to capture the full return on markets is correct, but has been mangled.  The actual evidence is that if your stocks pay a dividend then you need to reinvest them: which is commonsense, really.  We looked at this in Angels, Pinheads, Capital Gains and Dividends.
4. The evidence that we consistently overpay for growth stocks comes from a measure of something called Clairvoyant Value which uses hindsight to examine valuations of stocks.  See Clairvoyant Value and the Value Effect by Robert Arnott, Feifei Li and Katrina Sherred. As Arnott wrote in the Financial Times: “On average, a clairvoyant would have paid about 50 per cent more for the companies with lofty expectations than for the companies where stasis or disappointment is expected. But the market pays an average of about 100 per cent premium for the former, relative to the latter. The market overpays for future growth – relative to its ability to correctly anticipate that growth – by about two-to-one.” (see: Future Tips From Past Clairvoyants”).
5. There’s quite a lot of evidence around that the stocks we sell do better than the ones we buy.  For example, Terrance Odean and Brad Barber, in Online Investors, Do The Slow Die First, show that the stocks that online investors buy underperform that they sell by nearly 0.5% per month.  Interestingly this seems to be a facet of switching to trading over the internet – just because it’s easy to trade it doesn’t mean trading is easy. 
6. The 6% estimate comes from Monkey With A Pin.  The probability that this is wrong is quite high, but the trend towards losing money before we start due to paying high fees is strong.

Irving Fisher’s Big, Bad Call

1. To be fair to Fisher there are many judges who think he was right.  For instance, in The 1929 Stock Market: Irving Fisher Was Right the authors Ellen McGrattan and Edward Prescott argue that the markets in 1929 were undervalued on fundamental grounds.  All of which proves that being a stock market pundit is a fool’s game whichever way you do it.
2. A few people did predict the Wall Street Crash.  Roger Babson was famous for his bearish stance, although all predictions suffer from the curse of timing: if you predict a crash for years then, when it finally comes, are you really demonstrating good judgement?
3. Research on bond markets before both First and Second World Wars also suggests that markets – or people – weren’t expecting what turned out to be “obvious” with hindsight.  See the evidence from Why Markets Crash.
4. The best evidence for the failure of experts to predict anything comes from the studies of Philip Tetlock on political judgement.  See Good Judgement in International Politics: Correspondence and Coherence: Indicators of Good Judgement in World Politics, Thinking: Psychological Perspectives on Reasoning, Judgement and Decision Making, Harman, D. and Macchi, L., John Wiley & Sons, 2003

The Ross-Goobey Moment

1. Thanks to the marvel that is the internet many of Ross-Goobey’s papers are available on-line at The Pensions Archive.  
2. Interest in financial repression has recently increased, for good reason, with some superb work from Carmen Reinhart and Belen Sbrancia, discussed in How Sneaky Governments Steal Your Money.
3. The Ross-Goobey quote is taken from his address to the Ross Goobey's Address to the 1956 Conference of the Association of Superannuation & Pension Funds.
4. For Irving Fisher on money illusion see: Money Illusion.

Emotional Tulip Trading

1. The actual historical prices of tulips and their comparison with modern prices is a bit of a guess, but Rembrandt charged 1600 florins for The Night Watch  around 1642 while a rare bulb, a Violetten Admirael van Enkhuizen sold for 5,200 guilders in 1637.  See Tulipomania: The Story of the World's Most Coveted Flower and the Extraordinary Passions It Aroused by  Mike Dash.
2. There’s a lot of mystery around tulipmania, but the evidence that the story of supposed mania has been overblown is convincing.  See  Anne Goldgar’s Tulipmania: Money, Honour, and Knowledge in the Dutch Golden Age.
3. There are lots and lots of research articles on the Ultimatum Game, although the original one appears to be this one: An Experimental Analysis of Ultimatum Bargaining by Werner Guth, Rolf Schmittberger and Bernd Schwarze. 
4. Altruism remains a fascinating topic.  See, for example: Altruism: Signalling Corporate Fitness.
5. The evidence that studying economics actually makes you behave like standard economic theory predicts is fascinating.  For example, Economists Free Ride, Does Anyone Else by Gerald Marwell and Ruth Ames, and Does Studying Economics Inhibit Co-operation by Robert Frank, Thomas Gilovich and Deniis Regan.
6. Interestingly Herman Minsky’s “Financial Instability Hypothesis” reaches back to Irving Fisher’s work on Debt Deflation.  Still the best description of these crises is in Charles Kindelberger’s Manias, Panics and Crashes.

Voatility at Work

1. The Businessweek article on The Death of Equities remains fascinating reading.
2. The odd tendency of investors to get confused about real and nominal rates of corporations is addressed by Randolph Cohen, Christopher Polk and Tuomo Vuolteenaho in Money Illusion in the Stock Market:The Modigliani-Cohen Hypothesis.  
3. Choosing Portfolio Selection, Harry Markowitz’s paper from 1952, and Efficient Capital Markets: A Review of Theory and Empirical Work, Eugene Fama’s paper from 1970, is a bit arbitrary, but these were certainly two of a number of critical papers that triggered the efficient markets meme.
4. In truth there’s no absolute agreement on what happened in 1987, but portfolio insurance is plausibly implicated.  According to the Brady Report, the Presidential Report commissioned in the wake of the crash  “This initial decline ignited mechanical, price-insensitive selling by a number of institutions employing portfolio insurance strategies and a small number of mutual fund groups reacting to redemptions. The selling by these investors, and the prospect of further selling by them, encouraged a number of aggressive trading-oriented institutions to sell in anticipation of further market declines. These institutions included, in addition to hedge funds, a small number of pension and endowment funds, money management firms and investment banking houses. This selling, in turn, stimulated further reactive selling by portfolio insurers and mutual funds”.

A Personal Margin of Safety

1. Alice Schroeder relates of Ben Graham in The Snowball, her biography of Warren Buffett: “... his problem was capital. Through its stock-market losses the firm's account was down from $2.5 million to $375,000. Graham felt responsible for recouping his partners' losses, but that meant he would have to more than triple their money ... And, by December 1935, Graham did triple their money, and earned the losses back”.
2. Ulrike Malmendier and Stefan Nagel in “Depression Babies: Do Macroeconomic Experiences Affect Risk Taking?” find that the answer is “yes”. 
3. The idea that personal observation is often not enough to guarantee a proper understanding of markets is described by Maximilian Koestner, Steffen Meyer, and Andreas Hackethal in Do Individual Investors Learn From Their Mistakes?  Roughly the answer is that they  don’t because many of our biases aren’t things you can easily learn from.
4. The evidence for so-called “home bias” where institutions cleave to what they’re familiar with is very stong.  For example, Torben Lütje and Lukas Menkhoff in What Drives Home Bias? Evidence From Fund Manager’s Views find that many fund managers are irrationally confident about their ability to judge stocks they’re familiar with, without expecting to have to do any analysis to back this up.

Are You Satisficed?

1.  Herb Simon is the doyen of behavioural bias, and was also a founder of Artificial Intelligence studies.  Remarkably you can trace his ideas in both spheres to those of Alan Turing, the British scientist who laid down many of the fundamental principles of computing.  Anyway, the original Simon paper that introduced the concept of satisficing was published in 1958, Rational Choice and the Structure of the Environment.
2. The choice of jam for an example of satisficing isn’t an accident.  There’s a famous experiment in which consumers were presented with a choice of jam: those offered too many choices were less likely to make a purchase.  See Jam Today, Tyranny Tomorrow.
3. It would be impossible to do justice to the research of Tversky and Kahnemann, so I won’t even try.  Daniel Kahneman has published a book Thinking Fast and Slow which summarises a lot of his career.  Amos Tversky sadly died in 1996, but Kaheneman’s autobiographical note on the Nobel Prize website gives an insight into their work.
4. The evidence that losses hurt twice as much as gains is derived from Prospect Theory, the original paper for which was published in 1979 – Prospect Theory: An Analysis of Decision Under Risk. 
5. The idea of having upside and downside mental accounts, an extension of mental accounting, comes from Hersh Shefrin and Meir Statman.  See Behavioral Portfolios.
6. You can find the Superinvestors of Graham and Doddsville by a quick internet search.  It’s still well worth reading.
7. Mischel’s marshmallow test is justifiably famous.  How he accidentally stumbled on the long-term evidence for this, and what it means, is covered in The Secret of a Healthy, Wealthy Life.

Investing By Jerks

1. Jim Cramer getting all worked up about the Federal Reserve's failure to intervene is well worth watching: search for “Cramer: Bernanke, Wake Up”.
2. Karl Marx believed that capitalist systems were fundamentally cyclical and unstable: the “crisis theory”.  If you need some bedtime reading then Theories of Surplus Value should do it.
3. The Keeping Up With the Joneses bias – or at least the idea that people are concerned about consumption relative to their peers – was first suggested by James Duesenberry.  We looked at the relationship between relative consumption and happiness in Gross National Happiness.
4. The original paper for punctuated equilibrium was published in 1972, “Punctuated Equilibria: An Alternative to Phyletic Gradualism”.  Even today there’s still disagreement between scholars about how important punctuated equilibrium is for evolutionary processes.  However, most would agree that it has some role to play.
5. Schumpeter’s creative destructionism has historical links to Marx’s crisis theory.  It was first introduced explicitly in Capitalism, Socialism and Democracy in 1942.  See Time for Shiva and Schumpeter for more on this.

A Twenty-First Century Bubble

1. Ben Graham: “Furthermore, there is nothing to prevent the investor from dealing with his own investment problems on a group basis. There is nothing to prevent the investor from actually buying the Dow-Jones Industrial Average, though I never heard of anybody doing it. It seems to me it would make a great deal of sense if he did.”  See The Rediscovered Ben Graham.
2. Jack Bogle’s Vanguard is one of the great successes of the investment industry and one of the few innovations that has truly benefited the common investor.  See: Jack Bogle and the Bogleheads.
3. The research into the problem of index bubbles is discussed in Hubble, Bubble, Index Trouble.
4. There’s disagreement over whether the Nifty Fifty actually justified the high valuations paid for them (or even what the Nifty Fifty stocks were) – see http://www.aaii.com/journal/article/valuing-growth-stocks-revisiting-the-nifty-fifty and http://economics-files.pomona.edu/GarySmith/Nifty50/Nifty50.html.  Generally, though, I suspect this is a pointless argument, because few investors would have held the stocks this long anyway.
5. The (poor) active investment strategies of younger investors is analysed in How Not To Use An Index Tracker.

Free Will and Model Risk

1. A quick background to LTCM’s problems (and some discussion of portfolio management as well) can be found  in this paper by Yee Jun Xian and Eugene Tham on Modeling the (Mis)Behavior of Markets: Lessons for the Future. Perhaps the telling quote is “The fund was marketed to investors as using EMH to obtain supernormal returns, even while EMH itself claims that one cannot make supernormal profits consistently. If LTCM simply failed to make money, the reputation of EMH would be unsullied. Investors are unable to beat the market, after all. Hence, the case of LTCM disproves EMH in two ways. Firstly, they proved it possible to make large profits, profits that should have been impossible according to EMH. Secondly, they lost all their money when the market conditions changed drastically, an occurrence which also should not have been possible according to the EMH.”.
2. The classic example of how backward looking data isn’t really predictive of the future is David Leinweber’s Stupid Data MinerTricks which showed that Bangladeshi butter production could predict the movements of the S&P 500.  Is that likely in future?
3. Survivorship bias is a tricky issue, because it provides an upward bias in historical returns.  This hasn’t gone unnoticed by the financial industry as we saw in Survivorship Bias in Magical Mutual Funds.
4. The issues with computer models and the sub-prime crisis were discussed in When Muddled Modellers Muddle Models.