Episode 122 : Thinking Like A (Financial) Economist

In this conversation, Bob French interviews his father, Ken French, a professor of finance, about key concepts in economics and investing. They discuss the concept of marginal cost and marginal revenue, which helps individuals make decisions based on the balance between costs and benefits. They also explore risk aversion and how it affects investment decisions, as well as the winner’s curse, which refers to the tendency to overestimate the value of winning bids or investments. Overall, the conversation provides valuable insights into economic thinking and decision-making. In this conversation, Bob and Ken French discuss the challenges of drawing inferences about the future based on past performance in the financial markets. They highlight the winner’s curse and the noise in securities returns as factors that make it difficult to predict which asset class or active manager will outperform in the future. They also discuss the problem of overconfidence and the importance of accurate market prices. The conversation concludes with a discussion on the benefits of stock buybacks and the option value of investments. Listen now to learn more! 

Takeaways

Understanding the concept of marginal cost and marginal revenue can help individuals make informed decisions based on costs and benefits.

Risk aversion is driven by the decreasing marginal utility of wealth, where the value of each additional dollar decreases as wealth increases.

The winner’s curse refers to the tendency to overestimate the value of winning bids or investments, and it can be observed in various contexts, such as oil lease auctions and hiring decisions.

Considering these concepts can enhance economic thinking and decision-making in investing and other areas of life. Drawing inferences about the future based on past performance is challenging due to the winner’s curse and the noise in securities returns.

Overconfidence is a common problem in investing, and people often overestimate their ability to pick winning investments or active managers.

Accurate market prices are important for allocating resources efficiently and signaling the value of different activities.

Stock buybacks can be beneficial for companies and society, as they can signal undervaluation and allow companies to allocate resources more effectively.

The option value of investments should be considered, as companies may choose to buy back stock when they don’t have better investment opportunities.

Chapters

00:00 Introduction and Setting the Stage

09:19 Navigating Risk Aversion in Investing

31:46 Enhancing Economic Thinking and Decision-Making

45:39 The Importance of Accurate Market Prices

51:42 The Benefits of Stock Buybacks

Links: 

Register for the webinar with Retirement Researcher and Kenneth French! ’Five Things I Know About Investing’ Wed 4/24 at 2 eastern www.risaprofile.com/podcast

The Retirement Planning Guidebook: 2nd Edition has just been updated for 2024! Visit your preferred book retailer or simply click here to order your copy today: https://www.wadepfau.com/books/ 

This episode is sponsored by McLean Asset Management. Visit https://www.mcleanam.com/roth/ to download McLean’s free eBook, ”Is a Roth Conversion Right For You?”