The Keynesian Beauty Contest
What is the Keynesian Beauty Contest?
The Keynesian beauty contest is a concept from behavioral finance where participants gain by predicting the majority's choice rather than making personal judgments. Applied to stock markets, it suggests that investors profit more by anticipating popular stocks, rather than those with intrinsic value, leading to irrational price fluctuations.
The Basic Idea
How do you define beauty? You probably have a bevy of individual preferences. If asked, you could likely even give reasons about why you find certain things beautiful. However, if you have ever shared your opinions with other people, you might have realized that your standards of beauty are not universal: one person’s “beautiful” is another person’s “ugly.” Oftentimes, this diversity of preference is a good thing. In the dating world, our diversity of preferences enables everyone to find a partner– it would be pretty difficult if we were all vying for the same few people. But while our varied individual preferences may be useful in finding us a date, they are fueled by an irrational logic that can cause problems elsewhere.
The Keynesian Beauty Contest is an early theory in behavioral finance that describes how our perceptions of value can cause irrational fluctuations in supposedly rational systems. More specifically, it describes how short-term stock market fluctuations are not caused by changes in underlying value, but instead by investors attempting to figure out what others think the “average investor” finds valuable. According to this theory, attempting to time market changes is like trying to guess what your friend’s next partner will look like–you make guesses based on what you think they find “beautiful.” And in the same way we often fail to correctly guess our friends’ preferences, the Keynesian Beauty Contest shows that when we try to predict what others find valuable, we often get it wrong.
Successful investing is anticipating the anticipations of others.
– John Meynard Keynes, British Economist
About the Authors
Dan Pilat
Dan is a Co-Founder and Managing Director at The Decision Lab. He is a bestselling author of Intention - a book he wrote with Wiley on the mindful application of behavioral science in organizations. Dan has a background in organizational decision making, with a BComm in Decision & Information Systems from McGill University. He has worked on enterprise-level behavioral architecture at TD Securities and BMO Capital Markets, where he advised management on the implementation of systems processing billions of dollars per week. Driven by an appetite for the latest in technology, Dan created a course on business intelligence and lectured at McGill University, and has applied behavioral science to topics such as augmented and virtual reality.
Dr. Sekoul Krastev
Sekoul is a Co-Founder and Managing Director at The Decision Lab. He is a bestselling author of Intention - a book he wrote with Wiley on the mindful application of behavioral science in organizations. A decision scientist with a PhD in Decision Neuroscience from McGill University, Sekoul's work has been featured in peer-reviewed journals and has been presented at conferences around the world. Sekoul previously advised management on innovation and engagement strategy at The Boston Consulting Group as well as on online media strategy at Google. He has a deep interest in the applications of behavioral science to new technology and has published on these topics in places such as the Huffington Post and Strategy & Business.
