15 JUN


2018 FIFA World Cup , Absolute Return , Highlighted , Topics

Investing During the World Cup: a Question of Psychology?

At last! After long months of waiting, the kick-off of the 21st football World Cup is here. All eyes are riveted on Russia: this worldwide sport event is the 2nd most watched in the world (3.2 billion television viewers in 2014 in Brazil), right behind the Summer Olympic games (3.6 billion for the London Olympics in 2012).

Thirty-two nations are in contention. They represent more than 1.5 billion inhabitants (including Iceland, a demographic dwarf with 330,000 inhabitants), and nearly 37% of the world’s GDP (including Senegal, an economic dwarf with GDP of $16 billion). The two biggest global superpowers – the United States and China, together worth 40% of the economic weight of the planet – did not qualify.

The competition, which will create a sweet summer euphoria for one whole country on the evening of the 15th of July, the date of the final, will also cause disappointment, frustration and regret for the 31 other countries that will be eliminated during the next four weeks.

Can this sea of negative emotions, spread throughout a month, have an impact on the financial markets?

This question is worth asking in light of this astonishing statistic: since 1950, the American market[1] drops on average 2.6% during the World Cup periods (between mid-June and mid-July, approximatively every four years), contrasting with a gain of 1.1% during the same period for the years without the World Cup. Furthermore, among the 17 periods observed since 1950, 13 display negative performance.

Explaining the interaction between feelings/psychology and the financial markets is the goal of behavioural finance, which consists of applying psychology to finance. Born about thirty years ago, this theory has gained recognition with the “Nobel Prize for Economics”[2] being awarded to two of its fathers: Daniel Kahneman, in 2002, and Richard Tahler, in 2017. In opposition to the classical hypothesis of efficient markets, behavioural finance tries to shed light on situations where the markets are behaving in a non-rational manner, and to explain its causes by the psychology of its actors, basing itself on a whole series of experiments.

Let us take the best example – you, as investors – and let us determine together whether you are a rational agent.

1st choice. You must choose between:

  • a guaranteed win of 900 euros,
  • having a 90% change of winning 1,000 euros, and a 10% chance of not winning anything.

If you prefer the first answer, like most of the people interviewed, then you have an aversion for risk. On the financial markets, this bias can, for example, lead to a preference for the least risky assets, leading to suboptimal asset allocation.

2nd choice (independent from the first). You now have the choice between:

  • losing 900 euros,
  • having a 90% chance of losing 1,000 euros, and a 10% chance of not losing anything.

If, again, you are part of the majority by choosing the second option, you have an aversion for losses: you are more sensitive to the prospect of losses rather than of gains.

On the financial markets, the aversion to losses manifests itself by what is called the “disposition effect”, which is the tendency of investors to sell assets that have dropped in value too late.

And what about another emotional bias, well known to the investor: overconfidence? This refers to our tendency to overvalue our capacities (intellectual or other). For example, 82% of people stubbornly believe to be part of the … 30% that are the most cautious while driving. Studies show that overconfidence leads investors to buy/sell more quickly because they are convinced that they know more than their counterparties. Is there not a feeling of déjà-vu?

In other words, an investor is always subject to their own weaknesses: fear, overconfidence, or the tendency to overinterpret information based on their own beliefs. In theoretical terms, behavioural finance thus underlines the “bounded rationality” of the individual.

One of the main difficulties encountered by the specialists of behavioural finance is the organisation of experiments on a very large scale to be able to validate, or refute, their hypotheses. As such, the FIFA World Cup, because of its universality and the passions it generates, is a perfect laboratory to observe the effects of the collective disappointments and frustrations caused by the successive elimination of its participants. 

In 1972, the meteorologist Edward Lorenz introduced the concept of the “butterfly effect” with his famous question: “can a butterfly in Brazil cause a tornado in Texas?” Could there also be a “football effect”? Will the defeat of Brazil, Germany or any of the 30 other teams involved have an incidence on the financial markets? And as far as you are concerned, will the defeat of your favourite team influence your next investments?

Answers in 30 days! 

[1] NYSE Composite Index.

[2] The “Swedish National Bank’s Prize in Economic Sciences in Memory of Alfred Nobel”, established in 1968, recognises every year one or more people for their exceptional contribution in the economic sciences.