Maybe we should teach schoolchildren probability theory and investment risk management.
From Andrew Lo
Many of us like to think of financial economics as a science, but complex events like the financial crisis suggest that this conceit may be more wishful thinking than reality.
What makes this story so remarkable is that throughout my early childhood I had ongoing learning difficulties, particularly in mathematics. I struggled to learn the multiplication table, and no matter how hard I tried, I simply couldn't remember 6 times 7 or 7 times 8.
Most people are overconfident about their own abilities. That is probably a good thing. But we would be horrified if a physician's aide engaged in heart surgery.
My mother died of lung cancer last year. I felt helpless. As an economist, I thought, 'What can I do?'
Great investors need to have the right combination of intuition, business sense and investment talent.
While neurological studies have tried to identify components responsible for fear and greed, the impact on finance is less clear.
Some people might say, 'Can we afford it?' I think that's asking the wrong question... We should instead be asking, 'Can we really afford not to try?'
During periods of extreme fear or greed, you don't have the proper balance between those two to generate market efficiency and you get extremes in behavior.
It's important to understand how people perceive risk, and how that translates into investment behavior.
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