humorous turn analogous to the cheese shop game of Monty Python. That game is played as follows. One person, the customer, asks for a variety of cheese. The second person, the store owner, gives an excuse for why the cheese isnt available (for example, the cat just drank it was one answer in the original skit for a particularly runny cheese). Each player has to come up with a unique cheese or excuse, and the game ends when one side runs out of new ideas.

In our gasoline station variant, I propose new reasons why we have to stop and Barbara gives reasons why the present is a uniquely bad and inconvenient moment.

The gasoline game is simply a trivial demonstration of a self-control problem. Most of our bad decisions involve an inappropriate trade-off between today and tomorrow. We know that we should work hard now and play later, but we are just so busy now.

Behavioral economists have documented our self-control problems. In a variety of interesting settings we place too much weight on the present and too little on the future.32 We use our lizard brain when we ought employ our prefrontal cortex.

Woody Allen says that the brain is his second favorite organ. As we have seen, our brains are not monolithic bastions of rationality. While we have a powerful prefrontal cortex with special analytic power, it has only limited ability to control the wild and powerful lizard brain.

chapter three

CRAZY WORLD

Mean Markets and the New Science of Irrationality

How Can a Market Be Mean?

Theres a Wall Street adage that markets move to frustrate the most people. There is some suggestion that this is true. Contrarian lore tells us that when people are optimistic markets are likely to fall and pessimist sentiment is said to predict rallies. The more extreme the investors emotions, the more powerfully the market will move-but in the opposite direction of sentiment.

A mean market is one in which people are systematically out of sync with opportunity. In a mean market, our lizard brain screams at us to buy just before a collapse and makes us want to sell in terror just before a rally. If markets did create such emotional cruelty, especially because it costs us cash, they would indeed be mean. Are markets really mean, moving to frustrate us systematically?

There is one kind of market that can never be mean, and that is a rational market. To prove this point, try to be really wrong in predicting

coin flips. For example, flip a coin 100 times and predict each flip. It is almost impossible to get significantly more than half wrong. This is true regardless of what system is used to predict the outcome of each flip- astrology, tips from friends, or always predicting heads. Because a fair coin is unpredictable, it is equally cruel (and kind) to all efforts at prediction.

In a rational market, prices move like coin flips. In such a market, the chance of an up move in a short period of time should be almost exactly 50%. Furthermore, as with coin flips, nothing is supposed to be able to predict price moves. In such a market, all strategies to predict future price changes will be no better than chance. The bad news is that only those who are very lucky can do really well in a rational market. The good news is that it is also almost impossible to do really poorly in a rational market.

Therefore, for markets to be mean they must be irrational. We tackle the issue of market rationality first, and then return to mean (and nice) markets.

Are Markets Crazy?

We know that people are crazy. In addition to the scientific evidence that has piled up over the last several decades and that we reviewed in Chapter 2, surely our daily experiences confirm, at least anecdotally, that we are just not as rational as we think we are (or at least not as rational as old-school economists assume).

While the case against individual rationality is closed, this is not sufficient to prove that markets are irrational. Consider what happens when you put a bunch of crazy people together. Is the result more chaos, or can order emerge even from a group of irrational people? It turns out that both chaos and order are possible.

In February 2004, hundreds of people were killed in a stampede outside of Mecca, Saudi Arabia. As part of the hajj, huge numbers of Muslim pilgrims were participating in a rite where each one throws a pebble at a historical pillar symbolizing the devil. The crowd crushed the victims as people in the back pressed forward to reach the pillar within the