In the most recent Economist there was an article about how trading in the US markets is becoming increasingly passive, i.e. indexed, with the number of stock pickers declining. Since Giffen Goods, or those whose demand increases with their price, have always intrigued us, it occured to us just today that Index investing actually turns stocks into something similar to Giffen good.
This is because when you an index, you buy portions of each listed company in proportion to its market value, better known as price. Thus the higher priced the company, the more you buy. If a company's price rises further, and you index more money, you then you allocate even more of your money to this company. So while technically you don't buy a higher number of the company's shares if the price rises, you allocate more of your spending toward it.
We understand that this doesn't fit perfectly into the realm of Giffen Goods since quantity demanded should technically increase with price, but it seems pretty close. As new money comes into an index fund, it will allocate more and more to the stocks which have become more expensive nominally.
Momentum investing could also be see as falling prey to a Giffen Good. The higher a price goes, the more you buy... there are probably many more examples, please feel free to add any as a comment.
The best stock investing systems will be based principally on objective, measurable data. It's critical to "exorcise" the emotions from the investor's buy/sell decisions.
Posted by: Private Wealth Management | June 05, 2008 at 07:30 AM
Interesting. There are a lot of challenges out there for today’s investor—it can be difficult to make informed decisions. This site, http://investor.fisherinvestments.com/ features a number of helpful investor resources. This company is a client of mine and I have recommended the site to a number of my friends looking to learn more about investing.
Posted by: FI | March 29, 2010 at 04:10 PM