Subba’s Serendipitous moments

February 13, 2007

Does the Indian market reflect the wisdom of the crowds?

Filed under: Business,India,Perspective — Subbaraman Iyer @ 9:32 pm

Recently my learned friend Dr. Ananth Nageswaran raised a question in the MINT whether the Indian Sensex trading at an all time high is product of global liquidity or is it a reflection of India’s growth.

The site has some problems and is still in beta and hence I quote below some salient points:

He posits:

“To reiterate, the reason central bankers hesitate to intervene when asset prices keep climbing is that they find it unreasonable that a few men could overrule the judgement of hundreds and thousands of market participants. Perhaps, the real reason is that it is also politically unpopular to throw sands under the wheels of asset markets. In any case, it is hard to say whether asset prices were in a bubble or were discounting rational optimism (an oxymoron?) until after the fact. Precisely such a debate is under way in India right now. The all-important question is whether the Sensex, at over 14,000 points, is a product of global liquidity or is a rational reflection of the current and prospective high-economic growth in the country.”

He further adds: “In a way, acknowledging the final authority of the market is equivalent to acknowledging the existence of a power that dominates and consummates human endeavours. That is the first step towards spirituality. Spirituality starts with the admission by our egos that our opinions are not the final word on the subject—whether it is in the world of investment or otherwise”.

Having read the book The Wisdom of crowds by James Suroweiecki, I am curious to understand its application in financial markets. The book’s primary tenet is that a crowd defined as a group of people(investors) will typically be smarter and make better predictions than any expert. In the technology area there are many examples. It also talks about how the collective opinion of the punters in the race course picks up the winning horse more number of times than the experts and why more than 90% of fund managers perform worse than the overall market.

Now societies as a whole and Indian society more so, have traditionally placed a significant premium on the opinion of experts or gurus. Since we never had the Internet till recently, this was justifiably so. Now, with the advent of Internet, and more importantly the rise of social networking, and a very diverse group of people participating, the wisdom of the crowds is becoming a reality and an opinion which in many cases seem to run counter to the expert’s view . So currently in many domains there’s a very interesting debate about whether the experts view / prediction is likely to prevail / proven right or the view of the crowd will prevail.

I would like to hear views on how the expert’s view and the wisdom of the crowds as defined by James apply to emerging markets. Are they more pronounced in emerging markets than well developed markets?


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1 Comment »

  1. I do believe that there is a so called “intelligence” of the crowds and that thru the assimilation of information, the market reflects the values attributed and that is done with people buying and selling accordingly. The reaction to news is much faster than the pre E-trading days, when we had to call the brokers to make our calls.

    Back to the topic, i dug this up somewhere on the internet when I was researching for the intelligence (not wisdom) of the crowds…

    This is leaning to a “The Intelligence of Crowds” theory that the aggregate decision of many individuals is smarter than a few educated institutional investors.

    Why do the Japanese buy 20 year bonds when the yield on a 5 year is essentially the same? Because their institutional consensus process is so difficult. Once management finally gets an institutional decision made, the idea of not having to revisit that process for another 20 years instead of in 5 years is quite appealing, even if the rate return is exactly the same.

    Why do US locals prefer 90 day T-bills over longer term notes even when those notes are paying out more? Too many other choices. No one else in the US is offering a commission free 90 day investment outside Treasury Direct. But at the 6 month and longer periods no one puts their money in Treasury Direct because it’s pretty hard NOT to find someone paying a better rate for these longer periods.

    So who’s smarter –the US consumer who’s conditioned to shop for the best rate each time their CDs mature but is loathe to buy anything longer than 90 days from Treasury Direct, or the Japanese institutional investors on the long end doing the same thing they always have been doing.

    Or is it really even a competition? Could it be a bifuricated market with no connection between the two? A narrow curve could serve the two different markets fine. If the US Treasury wants to increase domestic ownership of the national debt the magic number is 3.5% and above on 90 day T-bills. Meanwhile the Japanese investors frankly don’t care about the five year and 20 year rates being the same as long as they don’t have to go through their consensus process often.

    It’s quite possible the two ends of the market are too split for it to be a very good indicator anymore.

    Comment by JPM — February 24, 2007 @ 4:41 am | Reply

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