The following is based on a talk I gave with Devpacific last Thursday in Vanuatu.
In a passage from his famous work The General Theory of Employment, Interest and Money, John Maynard Keynes presented a novel theory of how share prices are determined. Normally economists like to think of stock prices settling at an equilibrium level where supply and demand meet. The cost of shares is a fundamental property based on the present discounted value of a company’s future worth.
But Keynes thought otherwise, likening stock market investment to a newspaper beauty competition in which the winner is the person who predicts the most popular woman in the contest. Players won’t win by saying who they think is the prettiest; if they’re rational they should try to predict others’ probable choices. Other entrants will, if behaving sensibly, do the same thing, basing their submissions on others’ likely entries.
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