The GameStop Saga -- Is YOLO a Viable Risk Strategy?
Regular readers of Risklantern (I know you are out there, even though you are too shy to comment) will by now have heard of the tug-of-war over GameStop shares. As pretty much all news outlets have talked about it, I won’t go into detail; here is a good explainer, and this is a bit different but fun take:
If you're out of the loop - this is the (hilarious) story of a subreddit (wall street bets) taking down a multi-billion dollar hedge fund... get your popcorn ready
— Shaan Puri (@ShaanVP) January 26, 2021
The TL;DR is that GameStop, and offline games retailer that had been declared dead and heavily shorted by institutional investors, has been (at least temporarily) revived by mostly amateur day traders organizing via Reddit, causing huge losses to said investors. Whether you view this story as a comedy of justice or a cautionary tale about investing is an interesting discussion per se; in line with most commenters/articles I must admit to a hefty dose of Schadenfreude myself, in large part due to objections over the mechanics of shorting itself (you shouldn’t be able to sell what you don’t own). But besides the narrative of the little guy winning against Goliath [1], this is also an interesting view into competing views and strategies on risk. Objectively speaking, the business case for GameStop is pretty bad. The last time I went into an actual store to buy a computer game was at least 10 years ago, and that’s coming from an old guy. The last time I got a physical copy of a game I bought online probably five – usually it’s either Valve’s SteamStore or a Humble Bundle (which often ends up also being from Steam). To be fair, I haven’t owned a console in a while, where downloads don’t work the same way, but even there, GameStop is facing the usual brick-and-mortar issue – it’s just so much easier to order from an online retailer. In theory at least, the valuation of a company is supposed to reflect its discounted future cash flows. But that assumes rational actors who include all available information in rational decision making; even looking at many stock (and other) markets charitably as decision-making under uncertainty, it is pretty clear that rationality isn’t always the highest priority.[2] And a large part of GameStops share price increase (from under US$20 on January 1st to more than US$400 as of yesterday evening, with lots of ups and downs after online broker app Robinhood first restricted trading, then eased restrictions again) was due to the mechanics of shorting: the stock was massively overshorted (meaning that that more shares were borrowed than existed), and because the investor going short HAS to give back the borrowed shares at some point, simply refusing to sell massively drove up the share price. This isn’t the first time day traders pushed up a stock. Last year and after filing bankruptcy, Hertz’ stock saw a renaissance due to day traders using the Robinhood app. Sitting on a big bubble, the only issue for them will be to actually cash in on the position – Hertz has made it clear that they consider their shares worthless. So what are the lessons learned of the whole matter from a risk (or rather, a Risklantern) perspective?
Even a seemingly hyper-rational risk decision like where and how to invest made by professionals is due to the same irrational constraints that all of us mere mortals face: Ego, cognitive biases (more on that in an upcoming post), the failure to take other participants' psychology into account, and of course pure chance.
Even though the Reddit day traders weren’t teenagers, the risk taking behavior exhibited many of the same tendencies, with similar psychological background. In this case, it went well. That doesn’t mean it’s always a good idea.
In today’s high-information and –volatility age, markets are fairly easy to manipulate, whether inadvertently or illicitly. The wisdom of crowds only works if there are competing views and errors cancel each other out.
Notes: [1] “Little” is relative here [2] I am somewhat partial to the random walk hypothesis of share prices