Emerging Markets in an Upside Down World: Challenging Perceptions in Asset Allocation and Investment

Chapter 6

Core/Periphery Disease

Our view of the world matters. Our perception of the world is a simplification, a model – and none of our ideologies, as Greenspan calls them, can be accurate.

There are different views of reality. Is spin reality? Is perception sometimes more important than empirical observation? Clearly some powerful people think so. A senior adviser to former US President George W. Bush told journalist Ron Suskind (2004) that Suskind lived ‘in what we call the reality-based community’, where you ‘believe that solutions emerge from your judicious study of discernible reality.’ When Suskind started to respond, the aide cut him off: ‘That’s not the way the world really works anymore. We’re an empire now, and when we act, we create our own reality …’. Power is to a certain extent the ability to ignore the reality of others; to create new dominant thoughts which others follow and so to create new realities.¹

Markets are their own empire. They are self-referential in that the beliefs of market participants determine patterns of market behaviour which in turn appear to validate the beliefs. Risk perception, for example, is self-referential. Perceptions of risk (not merely independent events) determine patterns of market behaviour which appear to validate the risk perceptions, and so reinforce them. Such risk perceptions can drift a long way from objective likelihoods of loss. This is backed up by what we know from behavioural finance. People’s perceptions are biased ...