Prof. Jayanth R. Varma's Financial Markets Blog

Photograph About
Prof. Jayanth R. Varma's Financial Markets Blog, A Blog on Financial Markets and Their Regulation. This blog is currently suspended.

© Prof. Jayanth R. Varma
jrvarma@iima.ac.in

Subscribe to a feed
RSS Feed
Atom Feed
RSS Feed (Comments)

Follow on:
twitter
Facebook
Wordpress

January
Sun Mon Tue Wed Thu Fri Sat
         
31            
2021
Months
Jan

Powered by Blosxom

Sun, 31 Jan 2021

The rationality of r/wallstreetbets

Much has been written about how a group of investors participating in the sub-reddit r/wallstreetbets has caused a surge in the prices of stocks like GameStop that are not justified by fundamentals. I spent a fair amount of time reading the material that is posted on that forum and am convinced that most of these Redditors are perfectly rational and disciplined investors, and have no delusions about the fundamentals of the company.

Rationality in economics requires utility maximization, but does not constrain the nature of that utility function. It does not demand that the goals be rational as perceived by somebody else. Rationality of goals is the province of religion and philosophy: for example, Plato’s Form of the Good, Aristotle’s Highest Good, Hinduism’s four proper goals (puruṣārthas), and Buddhism’s right aspiration (sammā-saṅkappa). Economics concerns itself only with the efficient attainment of whatever goals the individual has. Even the Stigler-Becker maximalist view of economics (Stigler, G.J. and Becker, G.S., 1977. De gustibus non est disputandum. The American Economic Review, 67(2), pp.76-90) does not seek to impose our goals on anybody else, and does not require that the goals be pecuniary in nature (consider, for example, the Stigler-Becker discussion about music appreciation).

It is perfectly consistent with economic rationality for a person to buy a Tesla car as a status symbol and not as a means of going from A to B. Equally, it is perfectly consistent with economic rationality for a person to buy a Tesla share as a status symbol and not as a means of earning dividends or capital gains. Buddha and Aristotle might take a dim view of such status symbols, but the economist has no quarrel with them.

It is in this light that I find the Redditors at r/wallstreetbets to be highly rational. There is a clear understanding and Stoic acceptance of the consequences of their investment decisions. In this sense, there is greater awareness and understanding than in much of mainstream finance. When Redditors knowingly pay prices far beyond what is justified by fundamentals in the pursuit of non pecuniary goals, they are only indulging in a more extreme form of the behaviour of an environment conscious investor who knowingly buys a green bond at a low yield.

There is overwhelming evidence throughout r/wallstreetbets that these Redditors are focused on non pecuniary goals:

TL;DR: This sub was created to lose money.

/r/wallstreetbets is a community for making money and being amused while doing it. Or, realistically, a place to come and upvote memes when your portfolio is down.

Yo, health check time: Get proper sleep, Eat proper food, Stretch occasionally, HYDRATE. I’m sure we’ve all been glued to our screens all week, but please make sure you take care of yourselves.

There is a crystal clear understanding that most trades will lose money:

Buy High Sell low - what you do as a newcomer.

First one is free - A phenomena where you are so retarded and don’t know what the [expletive deleted] your doing you somehow make money on your first trade.

… if you don’t know any of this there is really no reason for you to be throwing 10k at weeklies you’ll lose 99% of the time.

We don’t have billionaires to bail us out when we mess up our portfolio risk and a position goes against us. We can’t go on TV and make attempts to manipulate millions to take our side of the trade. If we mess up as bad as they did, we’re wiped out, have to start from scratch and are back to giving handjobs behind the dumpster at Wendy’s.

… and also for the most part, they’re playing with their own money that they can actually afford to lose even if it hurts for a year or two.

Options are like lottery tickets in that you can pay a flat price for a defined bet that will expire at some point.

Indeed mainstream regulators could borrow some ideas from r/wallstreetbets on how to disclose risk factors in an offer document. When a risky company does an IPO, a prominent disclosure on the front page “This IPO was created for you to lose money” would be far better than the pages and pages of unintelligible risk factors that nobody reads.

Posted at 20:19 on Sun, 31 Jan 2021     2 comments     permanent link

Comments...

Ritwik Priya wrote on Sat, 13 Feb 2021 03:14

Re: The rationality of r/wallstreetbets

Sir

I believe the r/wsb and GME episode is yet another illustration that the 'revolution' is never a question of mass revolt, but of elite competition. You provide some snippets that show that there are people on it displaying rational behaviour with non-pecuniary motives, but it is more likely and equally compelling that these non-pecuniary interests are being manipulated by financially-sophisticated-but-not-quite-establishment players to provide liquidity and well-priced exits for the inevitable reversal in momentum. It's the new version of a pump and dump, but much harder to prosecute because the behaviour appears emergent or memetic and the people egging on the price action do not have fiduciary roles or compensation deriving from said egging. A key thing to note is the level of volumes that existed in GME even as the price kept gapping - something we wouldn't expect to see unless there was a lot of 'passing the parcel' between delta-hedging market makers, retail activity and big money playing silently.

I would like to believe that the r/wsb redditors are stoic heroes, but most evidence points to some of them displaying predatory behaviour on the others, who are simply the latest batch of individuals fooled into buying snake oil. Non-pecuniary snake-oil being even more potent than the more straightforward version in a world where material needs have been taken care of and a nihilistic boredom prevails.

A number of aspects of modern single-name security markets allow for short term negative convexity phenomena to build up, with only the truly sophisticated and resourced being in a position to manage the fall. The inclusion of certain names into the benchmark index forcing large pools of institutional indexed or index-tracking capital to shift into these names is yet another such situation ripe for disaster. But not before some meme-ing creates liquidity for the exit!