Richard Thaler On CUBA: “There Is No Rational Explanation”

Below is a new interview with Richard Thaler, published in today’s issue of the Swiss Business newspaper Finanz und Wirtschaft by editor Christoph Gisiger. Excerpts from the interview re-printed with permission.

What does that mean applied on the financial markets? Are investors always behaving rational?
Let me give you an example: There is this closed-end fund that has the ticker symbol CUBA and invests in the Caribbean. But of course, it cannot invest in Cuba because that would have been illegal since it was a US fund and because there are no Cuban securities. So it has nothing to do with Cuba. Historically, this fund traded at a 10 to 15% discount relative to the value of the assets that it owned. But one day it jumped to about a 70% premium and that was the day that President Obama announced his intention to relax relationships with Cuba.

What was the explanation for this sudden movement in price?
There is no rational explanation. You might think maybe a rejuvenated Cuba would help the entire Caribbean area. But if that were the story you would expect to see the underlying assets go up, things like cruise lines. But they didn’t. The value of the securities was the same. It was just the price you paid to get them packaged in this fund with the ticker CUBA that jumped, and it took about a year for this premium to go away.

You call those anomalies «fruit flies» of the financial markets. Why?
Coincidentally, the Nobel laureates in medicine last year studied fruit flies. We know that fruit flies are valuable to study in biological sciences, in part because they reproduce very often. But they’re not particularly important in the grand scheme of things for us humans. If there were no fruit flies, our live wouldn’t be very different. But they’re useful because they give us scientific insights. So the analogy is that these little anomalies like the story about the CUBA fund are not important in and of themselves. But they’re important in terms of what they can teach us about financial markets.

Another important concept in the conventional economic theory is the concept of sunk costs: Costs that have already been incurred and thus should be excluded from future business decisions. Why do we often neglect that concept in our daily lives?
I’ll tell you a funny story that I heard recently and that illustrates the sunk cost fallacy perfectly. There’s an American couple vacationing in the German part of Switzerland, let’s say in Zurich. So they buy two expensive tickets to what they believe is going to be a symphony concert. And then, as it’s supposed to start, they realize to their horror that it’s not a concert but a comedy theater production. Although they do not speak a word of German they stay for the next two and a half hours until the end of the play.

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