Professor Alex Edmans on the Madness of Markets — Why Smart People Make Crazy Decisions

What can financial markets teach us about human behaviour? Why might the size of a CEO’s signature tell us something useful about the company they run? And why, even when smart investors know something is probably a bubble, might they keep investing anyway?

Episode Summary
My guest on this episode is Professor Alex Edmans, who returns to the show to discuss his new book, The Madness of Markets: Why Smart Investors Make Crazy Decisions and How to Exploit Them. As the title suggests, this is a book about financial markets. But our conversation is really about something much broader: human behaviour.

Markets ought to be places where irrationality gets eliminated. They contain millions of participants, huge amounts of data and some of the smartest and best-paid people in the world. Yet people still overreact, follow the herd, become overconfident, refuse to admit mistakes and pay attention to things that shouldn't matter.

Alex explains why that happens and what it can teach us about decision-making beyond investing.We explore why seemingly trivial information can move markets, the fine line between conviction and delusion, and why information that's hiding in plain sight can sometimes tell us more than sophisticated financial analysis. Alex share why corporate jets, unusual locations for shareholder meetings and even the size of a CEO's signature can offer clues about how a company is run.

We also discuss information overload and our preference for things we can measure, why more disclosure isn't necessarily better disclosure, and how organisations can exploit the limits of human attention — including the strategic release of bad news on Friday afternoons.

He also considers the impact of AI; machines can process enormous quantities of quantitative information without some of our human biases, but qualitative judgements about character, culture and trustworthiness may still require people. The future, Alex argues, isn't necessarily human or machine, but human and machine. Along the way, we explore bubbles, loss aversion, sunk costs, incentives in investment banking, financial literacy and regulation.

And, ultimately, we return to a simple idea: markets behave irrationally because they're made up of human beings.

Guest Biography
Alex Edmans is Professor of Finance at London Business School, an author, speaker and expert on behavioural finance, responsible business and corporate governance. Before entering academia, Alex worked in investment banking at Morgan Stanley. His research has been widely published, and he has won numerous awards for teaching. His previous books include Grow the Pie and May Contain Lies, the latter of which was the subject of his previous appearance on the podcast.

Links
Alex Edmans' website: https://alexedmans.com/

Alex Edmans on LinkedIn: https://www.linkedin.com/in/aedmans/

The Madness of Markets: https://www.penguinrandomhouse.com/books/821903/the-madness-of-markets-by-alex-edmans/

Alex's previous appearance on the show — Professor Alex Edmans on Misinformation: https://www.humanriskpodcast.com/professor-alex-edmans-on-misinformation/

AI-Generated Timestamped Summary
[00:00:00] Introduction — what financial markets can teach us about human behaviour

[00:01:45] Why Alex wrote The Madness of Markets and why markets are driven by psychology as well as economics

[00:03:15] Markets as a laboratory for human behaviour — if millions of investors can get things wrong, what does that tell us about small groups making decisions?

[00:04:40] Three types of mistakes: overreaction, underreaction and focusing on the wrong information

[00:06:20] Loss aversion and the sunk cost fallacy — why admitting a previous decision was wrong is so difficult

[00:07:20] Combining memorable anecdotes with large-scale evidence, from Isaac Newton to market bubbles

[00:08:45] Why highly intelligent and sophisticated investors still make systematic mistakes

[00:10:40] Finding signals in unexpected places — why more data isn't necessarily better data

[00:12:20] What corporate jets, remote shareholder meetings, CEO photographs and signature sizes might reveal about leadership[

00:14:00] Information hiding in plain sight and how Alex's collection of unusual academic research became a book

[00:17:00] Why more corporate disclosure isn't necessarily helpful — and our preference for quantitative over qualitative information

[00:19:30] Creativity, silos and finding connections that other people miss

[00:21:00] Football, national mood and the stock market — demonstrating how emotion can affect prices

[00:23:00] Recognising our own humanity and why stress and emotion affect even highly experienced decision-makers

[00:24:00] AI and investing — what machines can do better and where human qualitative judgement still matters

[00:26:30] Why market inefficiencies don't disappear even after researchers reveal them

[00:28:00] Knowing there's a bubble but continuing to invest — why being right in the long term can still get you into trouble in the short term

[00:30:00] Investment horizons, other people's money and why your objectives determine what counts as a sensible decision

[00:31:40] Information overload — why watching markets too closely can make investors worse at investing

[00:33:15] How these principles extend beyond financial markets to housing, collectibles and other major decisions

[00:35:20] Mergers and acquisitions, investment bankers and the problem of misaligned incentives

[00:37:00] How organisations exploit human attention — including why bad news tends to arrive on Friday afternoons

[00:39:00] Could changing when and how we work help us notice information that everyone else misses?

[00:41:00] How writing the book changed Alex's own investment decisions, from rebalancing tech holdings to paying attention to fees

[00:43:00] Why Alex hasn't set up his own investment fund and how he applies behavioural insights to his portfolio

[00:46:00] Taking the broader view — why Alex prefers researching, teaching and explaining markets to running money

[00:48:00] Why The Madness of Markets was really 22 years in the making

[00:50:00] Democratising investing, financial literacy and helping people understand the risks they're taking

[00:53:30] Regulation, hidden costs and why making the right information salient may be more useful than simply providing more information

[00:55:45] Are markets really crazy — or are they simply an unusually visible example of humans being human?

[00:58:00] Why the lessons of the book ultimately go far beyond investing