Why Supermodels Are Like Toxic Assets

Fascinating economic discussion from 3 Quarks Daily, on how the market for supermodels functions:

“[Supermodel] Coco is what economists would call a winner in a “winner-take all market,” prevalent in culture industries like art and music, where a handful of people reap very lucrative and visible rewards while the bulk of contestants barely scrape by meager livings before they fade into more stable and far less glamorous careers. The presence of such spectacular winners like Coco Rocha raises a great sociological question: how, among the thousands of wannabe models worldwide, is any one 14 year-old able to rise from the pack? How, in other words, do winners happen?

The secrets to Coco’s success, and the dozens of girls that have come before and will surely come after her, have much less to do with Coco the person (or the body) than with the social context of an unstable market. There is very little intrinsic value in Coco’s physique that would set her apart from any number of other similarly-built teens—when dealing with symbolic goods like “beauty” and “fashionability,” we would be hard pressed to identify objective measures of worth inherent in the good itself. Rather, social processes are at work in the fashion modeling market to bequeath cultural value onto Coco. The social world of fashion markets reveals how market actors think collectively to make decisions in the face of uncertainty.”

What does this mean for finance? Consider:

“This social side of markets, it turns out, is key to understanding how investors could trade securities backed with “toxic” subprime mortgage assets leading us into the 2009 financial crisis . . .These formal and informal mechanisms result in a classic cumulative advantage effect in which successful goods accrue more success (also known as “the rich get richer” phenomenon, or by Biblical reference, the Matthew Effect) . . . In behavioral economics, a model’s success is a case of an information cascade. Faced with imperfect information, individuals make a binary choice to act (to choose or not to choose) by observing the actions of their predecessors without regard to their own information. In such situations, a few early key individuals end up having a disproportionately large effect, such that small differences in initial conditions create large differences later in the cascade.

Herding and cascades are rather problematic to financial markets; they leads investors to artificially bid up asset values, thereby leading to bubbles and eventual crashes, even if investors knew better all along, which, it turns out in the housing market, they largely did.

But because investors, like fashionistas, react to each other as well as to the aggregate traces of fellow investors’ actions, they exacerbate systemic risk.“ (emphasis added)

An unusual and interesting article worth reading.
source: Barry Ritholtz

Saverio Manzo
www.saveriomanzo.com