Meme stocks are causing a stir on the stock market. Small investors agree to collectively buy a share and thereby drive the price up. Probably the best-known example: the Gamestop hype at the beginning of the year. More recent cases are the rapid price increases of the cinema chain AMC or windeln.de.
Christian Rieck, economist and professor at the Frankfurt University of Applied Sciences, analyzes the phenomenon of meme shares in an interview with ntv.de – and uses game theory to do so. Among other things, this tries to derive optimal decisions in a wide variety of situations – for example, whether or not it is worth buying a share. Rieck also explains what investors can learn from game theory and why entering the hype about meme stocks can make sense.
ntv.de: You have a doctorate in game theorist. What’s your favorite game?
Christian Rieck: The funny thing is: I don’t like to play at all. I used to do a lot of board games and things like that, but I think the science behind them spoils you a bit. Unfortunately, if you spend too much time on board game theory, you eventually lose the fun with it.
The first stock exchange opened in Bruges around 600 years ago. Game theory, on the other hand, has been around for about 50 years. Are you a game theorist working on the topic?
In game theory, we model decisions in which several participants interact with one another. Millions of decision-makers act on stock markets and together influence a result. For this reason, the stock exchange is a very exciting field of research for game theory. But that hasn’t always been the case. For a long time, people pretended that the stock market was a pure game of chance.
Nobody knows when prices will rise or fall. That is an argument that the stock market is very much a game of chance.
It has some elements of chance, of course. But conceptually it is not a game of chance, but a strategic game. The main aim is to evaluate and manage risks. With a well thought-out strategy, investors can let probabilities work for them or use probabilities as strategic variables. We call this “mixed strategies”.
What can an investor learn from game theory for his own investment behavior?
The most important thing is to always realize that the others are not stupid either. As strange as it sounds, this is often overlooked or forgotten by investors. As a private investor, you usually do not have exclusive information. With many of them, however, I sometimes have the impression that they believe they have them after all. The argument to think one step further than anyone else is very common in the stock market. Practically everywhere investors tell you: “Yes, I have now understood that and I am the only one who has understood that and that is why I will get rich from it”. There are such cases, but they are very rare.
Game theory is often criticized for making assumptions that are too unrealistic. For example, that actors act purely rationally. Are investors acting rationally?
Of course, other factors also play a role – especially for inexperienced investors. But: Those who permanently detach themselves from what we describe as “rational” in rational theory lose influence on the market in the long term. Those who make mistakes too often or too big lose money and become less and less important. Those who are successful, on the other hand, gain more and more influence. Therefore, rational behavior spreads more than deviant behavior.
So-called meme stocks are currently coming into focus more and more frequently on the stock market. These are stocks that are mainly pushed through social media. Is it then rational as an investor to participate in this hype?
Maybe, yes. In fact, there are some not-so-complicated models that show that certain stocks can break away from their fundamental value. For example, an entire market may simply agree on a different assessment of a company than certain key figures initially suggest. Classic valuation principles such as cash flow or return on sales are no longer considered as much as they used to be.
In fact, with many meme stocks, very rarely talk of cash flow or ROI.
Exactly. Many market participants just have to agree on a different valuation – then it can even be sensible in the short term to join this valuation, because a self-reinforcing process arises. This is then a bubble that investors can benefit from for a short time, but which always collapses at some point. On average, however, you don’t earn more here than with “normal” stocks because you never know exactly when the bubble will begin and when it will end.
The most famous meme stock is Gamestop. What happened from your point of view?
Large investors and funds have speculated against the company on a large scale. They have been doing this for years and have never hurt each other. But now all of a sudden small investors come into play, who together develop a market power similar to that of the large hedge funds. And they are not included in this gentleman’s agreement and say: We’ll poke around here a bit and see how long they can hold out. Today we know: “They” didn’t last long and lost a lot of money in the process.
How do millions of retail investors who don’t know each other manage to buy the same stock en masse?
Through modern means of communication! The Gamestop hype is a classic coordination game – the better the communication, the better the coordination. In the past, this would of course not have been possible with telephones. Now you can meet on forums like Twitter or Reddit and read about what is happening in the markets. When the share price actually moves, more and more people jump on the bandwagon. And then an avalanche was set off, which can become gigantic in a very short time.
Modern means of communication have been around for a long time. There must have been other reasons for such hype.
The initiators used an old, yet very effective game theory trick: they set a focal point. A focal point is a solution that players choose when they cannot communicate with each other. In the case of Gamestop, it was a coded price target, a certain amount that the price should be whipped up to. In addition, an adversary was created with the hedge funds, which many perceived as “bad”. Such a narrative creates team dynamics on the retail investor side, which ultimately tipped the scales for the hype.
Do you have another example of a coordination game, for example from everyday life?
In principle, we find these coordination effects everywhere. For example in a department store: There people don’t walk around in a completely confused way, but more or less regular streams form. Sometimes there is just a little arrow and the little arrow ensures that a lot of people even start to coordinate in a certain direction. These small characters are also focal points, as we saw them in the Gamestop hype.
Do you think that the stock market will change as a result of neo-brokers and the associated onslaught of private investors?
I think so. For many financially strong short sellers, the rules of the game have changed a bit. Meme stocks like Gamestop or AMC did not exist until recently and of course hedge funds will now deal with the topic differently. Shortselling is now clearly becoming more dangerous.
Jakob Schreiber spoke to Christian Rieck
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