Blog: The Method and Madness Model of irrational behavior
Rational and irrational behavior defined by comparing the types of uncertainty we face with the decision making methods we use.
Back in May (Is the Fed "pause" good news or bad news?) I noted that the Fed appeared divided into interest rate hawks and doves. That schism is increasing and has now been noted by some of the broader media. This divergence, of course, increases uncertainty as well. So I thought it might be useful to review a model I created a few years ago that discussed decision making under different types of uncertainty. I called it, after Shakespeare, the "Method and Madness Model" or M3. The concept was published in a Journal of Behavioral Finance paper entitled "Simple and Complex Market Inefficiencies" and is available on the Publications page if you want a deeper dive.
M3 is an attempt to define rational and irrational behavior by comparing the types of uncertainty we face and the decision making methods we use. Often the method and problem don't match which results in my view of irrational behavior. M3 integrates behavioral finance, efficient markets and complexity theory. It is a conceptual model. No equations are involved, but it does challenge conventional wisdom.