Trade the Congressional Effect: How To Profit from Congress's Impact on the Stock Market

Chapter 4

Behavioral Finance, the Stock Market, and Congressional Dysfunction

When I first took geometry I had a terrific teacher named Mr. Kerbin, who wanted us to really imagine a universe of parallel straight lines and flat planes. To help us visualize that clear, unconflicted universe of the rational Greek mathematicians, we had a classroom in which we constructed parallel lines using tau strings that looked like they were the exact same distance apart across the whole room. For planes we had cardboard panels intersecting globes and slicing out circles. And, of course, there were triangles with right angles. It was inspirational teaching, and it fostered a love of math. Academic finance has for many years inhabited the same universe of parallel lines that never touch or bend apart. But as we learned from Einstein, in the real universe, straight lines of light eventually can become curved by gravity, and things are not always rational. A close measurement of those parallel strings would have shown them different distances apart at different points in the classroom.

Over the past 30 or so years, there has been a growing branch of finance theory generally known as behavioral finance. Traditional finance is expressed in a series of rational, Newtonian equations. I use the term Newtonian as shorthand for “unbiased,” without being impacted by the act of measurement itself, and for constant equations. As Meir Statman pointed out, the vast bulk of traditional finance theory is the ...