17 September 2010

Rational Fools

Rational fools, is the tile of a seminal paper by Amartya Sen which I read quite sometime ago and I will not deal with it here, but got reminded of this because of a recent seminar. The essence of the presentation was based on a fact that on average, one particular sub-group (individual investor) made losses whereas another sub-group (institutional investor) made profit. Superimposing a definition of rationality/irrationality with profit/loss, the conclusion is that individual investors are irrational. And by extension, they are 'fools'.

Nevertheless, a few questions keep bothering. Are investors behaviour of rationality/irrationality to be judged by outcomes alone? If size of the pie is increasing then what prevents both sub-groups from making profit? Is there no role of uncertainty, information asymmetry, transaction costs, rent seeking and so on and so forth? These questions were put aside because they were outside the purview of the model or without empirical basis or pure semantics. Lest one gets further bewildered, this is a journey from irrational fools to rational fools.

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