By 2009, that long-term investor’s stake would have risen to $ Over the same period, the momentum traders’ stake would have returned $ Buy-and-hold would have out-performed bought-and-sold by a factor of around 36. How different the world may have looked. Fundamentals would have triumphed over momentum. The sheep would have been herded by the goats. Facing a losing streak, speculators may have gone the same way as despairing Dick Fuld or the ravenous robin. The gene pool may have been cleansed of the impatient. Patience may have helped ward off great disaster, the like of which we have recently seen. Just as patience can ward off great disaster, impatience can ruin a whole life. Generations of dieters and addicts are testament to that. So too is finance, not least in the light of the crisis. It is important finance sticks to the patient evolutionary path. To do so, the fidgeting fingers of the invisible hand may need a steadying arm. 14  BIS Review 114/2010  Annex  BIS Review 114/2010  15  16  BIS Review 114/2010  BIS Review 114/2010  17  18  BIS Review 114/2010  References Ainslie, G and Haslam, N (1992), “Hyperbolic Discounting”, Choice Over Time, Russell Sage Foundation. Ainslie, G (1974), “Impulse control in pigeons” Journal of the Experimental Analysis of Behaviour 21(5). Angeletos, G, Laibson, D, Repetto, A, Tobacman, J and Weinberg, S (2001), “The Hyperbolic Consumption Model: Calibration, Simulation, and Empirical Evaluation”, Journal of Economic Perspectives 15(3), pp 47–68.

Finance has both these raw ingredients. Most traders’ brains harbour the impatience gene. Often, they harbour little else. And traders’ behaviour is shaped every bit as much by the footfall of their friends in the herd. So, in theory, we might expect similar cycles of selfdestruction and self-improvement in finance. Gresham’s law in finance To illustrate these theoretical dynamics in action, consider a sketch model. Imagine three classes of investor:   an impatient short-term speculator, who follows the momentum of the herd, buying when prices are rising and selling when they fall;    a patient long-term investor, who invests according to where prices are relative to their long-term fundamentals;    an untested investor, who can mimic either the speculator or the long-term investor, but whose performance either way is assessed at frequent intervals by endinvestors who withdraw or maintain funds accordingly. Market prices in this model are buffeted by two winds. Momentum-based speculators cause deviations from fundamentals, while long-term investors drive prices back towards fundamentals. These are the double-selves of the financial brain, the patience and impatience genes. And as in social systems, the balance of these two genetic types results in two very different evolutionary equilibria. Under one equilibrium, patience wins the day. When long-term investors start in the ascendency, prices tend to correct towards fundamentals. The performance of untested investors pursuing momentum strategies falters, while those pursuing long-term strategies flourish. The fraction of long-term investors rises. The self-correcting tendencies of market prices are thus reinforced, further supporting long-term investors.