Behavioral Finance - Impatience

Tim Harford comments that Thaler and Sunstein have an optical illusion at the beginning of chapter one of Nudge. Their point: the human brain has evolved to take short cuts in the way it processes information, short cuts that sometimes lead us astray. Hence, sometimes we could use a little help in nudging us towards the correct decision when we make mistakes. ''That's right, I am not very happy with the unbalanced emphasis on stock price and market cap and short-term earnings,'' Dr. Drucker said in an interview. ''The most critical management job is to balance short term and long term. In the long term, today's one-sided emphasis is deleterious and dangerous.''

"Short cuts" and "short term" as described above can be termed as impatience. This trait is an integral part of human nature. Human beings are by their very nature are impatient. Quran declares this in Aya 19 of Sura Al-Ma'arij "Truly man was created very impatient". The case in hand is the "Efficient Market Hypothesis" (EMH). EMH is an example of impatience. Andrei Shleifer explained EMH

"The basic theoretical case for the EMH rests on three arguments which rely on progressively weaker assumptions.

1. First, investors are assumed to be rational and hence to value securities rationally.
2. Second, to the extent that some investors are not rational, their trades are random and therefore cancel each other out without affecting prices.
3. Third, to the extent that investors are irrational in similar ways, they are met in the market by rational arbitrageurs who eliminate their influence on prices.

When investors are rational, they value each security for its fundamental value: the net present value of its future cash flows, discounted using their risk characteristics. When investors learn something about fundamental values of securities, they quickly respond to the new information by bidding up prices when the news is good and bidding them down when the news is bad. As a consequence, security prices incorporate all the available information almost immediately and prices adjust to new levels corresponding to the new net present values of cash flows."

Adjusting the security price "almost immediately" by incorporating any good or bad news is one of the manifestation of impatience. The story of United Airlines is a good example of this behavior.

The steep sell-off in United’s shares came after a news service in Florida distributed an old story posted on the South Florida Sun-Sentinel Web site six years ago. Monday’s recirculated story gave the appearance that United had filed for bankruptcy protection again. In fact, the story was originally published Dec. 10, 2002, by the Chicago Tribune, marking the airline’s decision at that time to seek protection from creditors. And more importantly for us, moments after a headline for the story hit Bloomberg, shares in United stock fell from about $12 a share to a low of $3, prompting a halt in trading of United stock.

Of course, once the truth was out the stock got back to a slightly lower $10 odd.

The second manifestation of the impatience is the theory of Arbitrage, which induces so called rational investor to loose their patience.

"A textbook definition (Sharpe and Alexander 1990) defines arbitrage as ‘the simultaneous purchase and sale of the same, or essentially similar, security in two different markets at advantageously different prices.’ Suppose that some security, say a stock, becomes over-priced in a market relative to its fundamental value as a result of correlated purchases by unsophisticated, or irrational, investors. This security now represents a bad buy, since its price exceeds the properly risk adjusted net present value of its cash flows or dividends. Noting this overpricing, smart investors, or arbitrageurs, would sell or even sell short this expensive security and simultaneously purchase other, ‘essentially similar,’ securities to hedge their risks. If such substitute securities are available and arbitrageurs are able to trade them, they can earn a profit."

But it is not so simple and easy to make money. In doing so the rational trader can make a huge loss. Barberis and Thaler describe as "Noise trader risk, an idea introduced by De Long et al. (1990a) and studied further by Shleifer and Vishny (1997), is the risk that the mispricing being exploited by the arbitrageur worsens in the short run. Even if General Motors is a perfect substitute security for Ford, the arbitrageur still faces the risk that the pessimistic investors causing Ford to be undervalued in the first place become even more pessimistic, lowering its price even further. Once one has granted the possibility that a security’s price can be different from its fundamental value, then one must also grant the possibility that future price movements will increase the divergence. Noise trader risk matters because it can force arbitrageurs to liquidate their positions early, bringing them potentially steep losses. To see this, note that most real-world arbitrageurs—in other words, professional portfolio managers—are not managing their own money, but rather managing money for other people. In the words of Shleifer and Vishny (1997), there is [“a separation of brains and capital.”]"

Impatience in adversity and as well as in pursuit of something good is disliked in Islam. Here are few Hadith of Prophet (PBUH) on the subject.

Narrated Nafi

Ibn 'Umar said, "Allah's Apostle said, 'If the supper is served for anyone of you and the Iqama is pronounced, start with the supper and don't be in haste (and carry on eating) till you finish it.' " If food was served for Ibn 'Umar and Iqama was pronounced, he never came to the prayer till he finished it (i.e. food) in spite of the fact that he heard the recitation (of the Qur'an) by the Imam (in the prayer). Narrated Ibn 'Umar: The Prophet said, "If anyone of you is having his meals, he should not hurry up till he is satisfied even if the prayer has been started."

Sahih Al-Bukhari 1.642

Narrated Abu Huraira

Allah's Apostle said, "The invocation of anyone of you is granted (by Allah) if he does not show impatience (by saying, "I invoked Allah but my request has not been granted)."

Sahih Al-Bukhari 8.352

Narrated Al Hasan

'Amr bin Taghlib said, "Some property was given to the Prophet and he gave it to some people and withheld it from some others. Then he came to know that they (the latter) were dissatisfied. So the Prophet said, 'I give to one man and leave (do not give) another, and the one to whom I do not give is dearer to me than the one to whom I give. I give to some people because of the impatience and discontent present in their hearts, and leave other people because of the content and goodness Allah has bestowed on them, and one of them is 'Amr bin Taghlib.' " 'Amr bin Taghlib said, "The sentence which Allah's Apostle said in my favor is dearer to me than the possession of nice red camels."

Sahih Al-Bukhari 9.626