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03/03/2010

Research Overview: Phantastic Objects and the Financial Market’s Sense of Reality


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David Tuckett and Richard Taffler have an interesting paper recently published in the International Journal of Psychoanalysis entitled “Phantastic Objects and the Financial Market’s Sense of Reality: A Psychoanalytic Contribution to the Understanding of Stock Market Instability.” The article suggests that in the context of uncertainty and ambiguity, emotions and states of mind determine the way information about reality is processed. Three questions are posed as follows:

  1. Why do a dominant proportion of people during a financial bubble appear to become incapable of using relevant information in their assessments? 
  2. Why do anger, blame, and the search for scapegoats erupt after the bubble bursts rather than guilt? 
  3. Why does the information available not change but the seeming attitude of how to use it does? 

The condensed response is that we identify exciting developments (think of the dot com bubble) as an object of “phantasy” (the authors use the term “phantastic object”). As such, it fulfills a deep desire to have exactly what we want, when we want. Such “phantasies” have the effect of overriding more realistic calculation and judgment. In fact, the study suggests that we “split off” such “phantasies” from our ordinary rationale and evaluation process so that we avoid bad mental experiences. There is also some evidence cited that involvement with groups can enhance the likelihood of the condition and reinforce the suspension of rationality. 

If the bubble ascends, the overvaluation of the euphoria of “phantasy” objects is irrationally excessive, thus, when there is a catalyst for the fall, the reaction is blame rather than analysis. People look for scapegoats to prosecute. Valuations of the object are also irrationally low during this stage.

Prior to achieving a more realistic and rational process for valuation, there must be a time of mourning in which the transition of “phantasy” to reality must take place. During this phase, the individual must grapple with the pain of accepting guilt for personal responsibility and thereby develop a more realistic perspective. Eventually, the ability to exercise more rational valuations emerges. 

The article ends with several observations that rationalize economic theory regarding markets and how they reinforce rather than diffuse the potential for such situations. 

Potential Application: We should be able to develop a test for the degree of existence of “phantasy” objects by investors. By monitoring the proportions of market participants and the depth of their embrace of “phantasy” objects, we could create a dataset that could then be correlated with actual market performance. The result would be a bubble indicator.

For more information about behavioral finance topics, please contact Mark Harbour

--Mark Harbour, President, the Applied Behavioral Finance Group (ABFG)

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