Two Models of Investor Behaviour
Professor Stout identifies two models of investor behaviour: (1) the rational expectations investor, and (2) the trusting investor (Lynn A. Stout, The Investor Confidence Game, 68 Brook. L. Rev. 407 (2002) – see reference list).
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She assumes and, correctly so, that investors invest to make money. However, she asks a deeper and more difficult question: why do investors believe they will profit by making investments in the financial markets. Empirical evidence bears out questioning that assumption. For example, in 2000, NASDAQ lost 75% of its total market capitalisation. The recent global financial crisis equally pierces a searing hole in this belief system. Lehman Brothers, a notable Wall Street investment bank went bankrupt, thereby undercutting the assumption that the professional money manager knows its business. Merrill Lynch, a widely known securities firm that, arguably if it had a EU counterpart, would function as an institutional shield of investor protection, lacked the judgment to maintain the company as an on-going concern, forcing it to be acquired by Bank of America (Bank of America acquired Merrill Lynch on 15 September 2008 in an all-stock transaction. Bank of America Buys Merrill Lynch, Creating Unique Financial Services Firm, available at http://www.ml.com/?id=7695_7696_8149_88278_106886_108117, last visited 12 November 2008. Since September, the share price of Bank of America has plummeted from $USD 25.59 to $USD18.69, a decline of approximately 30% of its value in 3 months).
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The conventional answer to this question is the model of investor behaviour called the “rational expectations” investor model.
