Stumbling and Mumbling

Author: chris dillow   |   Latest post: Fri, 20 Apr 2018, 01:48 PM


Experience matters

Author:   |    Publish date:   |  >> Read article in Blog website

There might be a link between the age gap in British politics and the recent sell-off in bond markets.

I'm thinking of here of some work by Ulrike Malmendier. She's shown that experiences in our formative years influence our behaviour years afterwards. For example, investors who experienced recessions in their youth are less likely (pdf) to hold equities than otherwise similar people who didn't, and company bosses (pdf) who experienced such recessions are less likely to use external finance.

Her work chimes with me. I've always been risk averse, perhaps because of circumstances I experienced in my youth.

Recent experiments by Pieran Jiao at Nuffield College Oxford have corroborated this. He gave some subjects a long position in shares and others a short position, and then showed them the share price moves, so that some saw profits and others losses. He then asked subjects to predict subsequent price moves. He found that those with long positions who had made a profit predicted higher future prices than others. Conversely, those with short positions who had made profits predicted further price declines.

All this suggests that direct experience of something slightly distorts our future expectations. Experience of profits makes us optimistic, whilst experience of recessions makes us gloomy. This fits with David Hume's distinction between impressions - our "more lively" sensations induced by direct experience - and ideas which are "less lively." Impressions impact our expectations more than mere ideas.

Which brings me to the bond sell-off. Older traders remember the "bond massacre" of 1994, when a widely-expected Fed tightening triggered a slump in the market. And they have a mental image that "normal" interest rates are much higher than they are now - because what's normal is what we experienced in our impressionable years. These impressions make them jumpy when central bankers talk, however Delphicly, about normalizing monetary policy.

In fact, these being financial markets, it's not necessary for traders to actually possess such impressions themselves. If they fear that others have such impressions - or fear that others will fear that others might have them and so on - that is enough for the prospect of normalization to cause a bond sell-off.

A similar mechanism might explain oldsters' greater antipathy to Labour. Jeremy Corbyn's links with the IRA look awful to many people old enough to remember the Birmingham pub bombings, but they don't mean much to voters who weren't even of school age when the Good Friday agreement was signed. And Tory attempts to scare voters with talk of Labour's fiscal incontinence resonate with those who remember Britain "going cap in hand to the IMF", and who regard high borrowing costs as normal. But they just elicit a shrug to people with no such memories.

Even for the most historically aware of young voters, the Troubles and the IMF crisis are - in Hume's words - faint ideas rather than the lively impressions they are to oldsters. That's a significant difference.

Perhaps, therefore, there are genuine lasting differences between different age groups. And these arise in part because our beliefs are shaped not just by current reality but also, partly arbitrarily, by the past.

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