He has spoken at Davos, testified in the UK House of Commons, and reached millions through his TED talks and contributions to the BBC, CNBC, and The Guardian. He is the author of May Contain Lies, which received huge acclaim from the Times, The Guardian, Wall Street Journal, and the Financial Times. His first book, Grow the Pie, was a Financial Times Book of the Year.
Edmans applied the “Page 99 Test” to his new book, The Madness of Markets: Why Smart Investors Make Crazy Decisions–and How to Exploit Them, and reported the following:
Page 99 of The Madness of Markets: Why Smart Investors Make Crazy Decisions – And How To Exploit Them is about herd behavior in investing. It says:Visit Alex Edmans's website.But blindly copying someone else’s trades is too naive a strategy. What really matters is access to information. The skill lies in taking other people’s insights, mixing them with your own research, and then deciding whether to act. Veronika Pool, Noah Stoffman and Scott Yonker studied how fund manager networks affect how they select their stocks. They found that, when investors happen to live in the same neighbourhood – literally just down the street – their portfolios overlap more than if they only share the same city. Looking this closely rules out other explanations like city-wide newspapers or a conference coming to town. And when money managers become neighbours, the overlap only appears after the move, not before – so it’s not just similar preferences. Most importantly, the information they shared was useful. Trades linked to neighbourhood ties outperformed by 6-7% per year: what spreads from over-the-fence chats is signal, not smoke. Sometimes, the crowd really does have wisdom.The Page 99 Test works well for several reasons. First, the book is based on top-tier academic research that’s but highly relevant for practitioners. These papers are on whether following the crowd improves returns. Second, the book is nuanced. It’s easy to say that following others is mindless mimicry, but data isn’t always on the side of the snark. It depends on who you’re following and what. Page 98 describes a study which shows that fund managers who simply copy their peers’ trades underperform. However, Pool, Stoffman, and Yonker study connections with fund managers, rather than simply mimicking fund managers. If you discuss ideas with them, this might indeed be valuable – just like working on a group project at school helps you learn more than copying your classmate’s homework. The Facebook study investigates connections with friends, rather than professional fund managers, and page 100 explains how it doesn’t improve returns.
But fund managers don’t just talk shop with other fund managers. Their circles are wider. As we’ve seen, Facebook allows us to trace these broader networks. That earlier study [by Michael Bailey, Ruiqing Cao, Theresa Kuchler and Johannes Stroebel] measured friendships between individuals; a similar research team linked entire places. They built a “Social Connectedness Index”, which measures how strong Facebook friendship ties are between two areas.
Page 99 is part of Chapter 4 of the book, “Monkey See, Monkey Buy: Viral Herding in Markets”. It discusses one of the newest and most exciting strands of research in finance – social forces – and one that is particularly relevant for the real world. In the past, interaction was confined to people you see at work or in the pub. Now, you can discuss stocks with Facebook friends you haven’t seen for years, or Redditors without even knowing their name or face.
Neither copying everyone blindly nor tuning everyone out is the way to go. Instead, you should distinguish signal from smoke, and decide whether you want to learn from the crowd, front-run it, or bet against it. The danger lies in drifting from one role to another without realizing it. Herding can ruin you – or it can rescue you. The key is knowing which footsteps are worth following.
The Page 99 Test: May Contain Lies.
--Marshal Zeringue
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