Crowds and irrational behavior

Neuroscientists have discovered the physiological basis for two of the most fundamental responses to the conduct of human behavior, particularly with regard to behavioral economics: greed and fear. These are the two impulses that drive money and markets, and even religion.

According to science, the limbic system that divides the brain into the right and left hemispheres is triggered by outside stimuli that are transferred through the temples on the forehead and behind the eyes.

But the analysis in the brain very rarely follows rationality. Rather, it follows our own “rationalization” of reality and not of reality. in itself.

This difference will be profound if only we analyze our responses. The brain is more receptive to stories or narratives than to numbers and cold data, and therefore a tale is more likely to be accepted and put into practice than an array of numbers.

In rationalistic terms, the latter should guide us further, but the fact is exactly the opposite.

In a new finely written book The illusion of crowds, William J Bernstein, author of earlier titles such as Rational expectations and The intelligent asset allocator, discusses the reasons for crowd behavior or herd mentality in a logical analysis of various events in recent history.

Tables vs tales

He doesn’t draw definitive conclusions, but after reading the book, one realizes the need to focus more on data than on inferences, tables than tales, statistics than stories.

The ideal result is when we can balance both inside our brain / mind and then come to conclusions.

Most often, but the crowds that we are all a part of – whether in an office boardroom or in an economic / political / religious congregation – tend to absorb narratives that lead to unintentional irrational behavior or behavior. streamlined that suits our intuition.

Herd delusions

It may be called the herd mentality, but the examples cited by Bernstein have been repeated so often in history that it is not just a “mentality” but illusions that the crowds suffer from.

Otherwise, sane people tend to go crazy in groups. This happens with religion as it does with the stock markets.

The booms and busts of the past four centuries and the religious waves, whether benign or malignant, have all resulted from this trait of human behavior.

The theme is not exclusive to the 21st century. In 1841, the Scottish Charles Mackey wrote Memories of extraordinary popular illusions who recounted several episodes of mass mania, linked to religion or money. It has since been popular reading on this topic.

Bernstein states in the Prelude that “people do not deploy the powerful human intellect to dispassionately analyze the world, but rather to rationalize how facts conform to their emotionally derived perceptions.”

Irrational past

It is stated that Mackey himself fell victim to the madness of the railway stock market in Britain in 1843, when investors supported the growth of the railway lines from 2000 to 5000 in 1848 and thousands extra miles, which were planned but never built. The shares of thousands of investors have gone bankrupt. Mackey was one of them !. Those familiar with the stock market would have heard of the Dutch tulip mania of the 1630s (when investors bet heavily on the prices of tulip flower bulbs) and the two stock bubbles in Paris and London in 1719-20.

Busts and crowds

The bust of Dotcom at the turn of the century and the collapse of 2008 are recent examples of the great illusions of crowd behavior. The brightest and best minds lost money even when they apparently acted on mathematical models built on rational principles. The border between the rational and the rationalized is indeed quite thin and what is surprising is that this tendency tends to be repeated.

The religious folly of the Crusades and contemporary trends in Islam (and Hinduism, at the political level) prove the theory that the “rationality” of behavior and thought is, as the author puts it, “a fragile cover perilously balanced on the cauldron bubbling with artifice and self-delusion ”.

The press (the media) and the politicians are not too minor actors in this drama and they feed the mania until its logical conclusion. Technology and the availability of cheap money are factors that have propelled these trends in recent times. Fiat money (where the currency is printed without any backup reserve) makes the formation and development of bubbles extremely fast. Before the inevitable bust happens.

Interestingly, the more the “group” or “crowds” interact, the less rational individuals become. Frederich Nietzsche said: “Insanity (not physiological) is rare in the individual – but with groups, parties, peoples and ages, it is the rule”.

Accordingly, the correctness of the overall judgment of a group lies in the fact that the group does not behave like a crowd.

In an age when cryptocurrency fads and irrational exuberances (of Greenspan’s fame and recently used by our own RBI Governor Shaktikanta Das) in the markets resemble Macbethian ambitions that ‘fall on the other’, the relevance of mass illusions will continue to dominate our ex post analysis.

The reviewer is a chief executive officer of SBI. Opinions are personal.


William J. Bernstein is a neurologist, financial theorist, and historian whose books include A Splendid Exchange, Masters of the Word, The Birth of Plenty, and The Four Pillars of Investing. He is a co-founder of investment management firm Efficient Frontier Advisors and has written for publications such as the Wall Street Journal and Money magazine. He won the 2017 James R Vertin Award from the CFA Institute. He lives in Oregon.

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