Portfolio theory: The human factor

Computers can do a lot to process today's explosion of information in financial markets - but they're only a tool. The ultimate processor and user of the information is man. Man is the subject and the object of financial analysis. Markets are a theatre of human behaviour. More and more quantitative analysts are redirecting their study of markets to the study of man. David Shirreff reports.

The study of markets is still in its infancy. We know that, when only three or four people gather together to trade, there is already a recognizable market. At that level, game theory can explain a lot, as participants take account, not only of the fundamentals governing the commodity traded, but also of each other and the views they might take. But even at this level, game theory might explain behaviour, but it cannot predict market outcomes.

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