What Are Animal Spirits?

“Animal spirits” is a term coined by the famous British economist, John Maynard Keynes, to describe how people arrive at financial decisions, including buying and selling securities, in times of economic stress or uncertainty. In Keynes’s 1936 publication, The General Theory of Employment, Interest, and Money, he speaks of animal spirits as the human emotions that affect consumer confidence.

Today, animal spirits describe the psychological and emotional factors that drive investors to take action when faced with high levels of volatility in the capital markets. The term comes from the Latin spiritus animalis, which means “the breath that awakens the human mind.” In some ways, Keynes’ insights into human behavior predicted the rise of behavioral economics.

Understanding Animal Spirits

The technical concept of spiritus animalis can be traced as far back as 300 B.C., in the fields of human anatomy and medical physiology. There, animal spirits applied to the fluid or spirit present in sensory activities and nerve endings in the brain that resulting in mass psychological phenomena like manias or hysterias.

Animal spirits also appeared in literary culture, where they referred to states of physical courage, gaiety, and exuberance. The literary meaning implies that animal spirits can be high or low depending on an individual’s degree of health and energy.

Animal Spirits in Finance and Economics

Today in finance, the term animal spirits arise in market psychology and behavioral economics. Animal spirits represent the emotions of confidence, hope, fear, and pessimism that can affect financial decision-making, which in turn can fuel or hamper economic growth. If spirits are low, then confidence levels will be low, which will drive down a promising market—even if the market or economy fundamentals are strong. Likewise, if spirits are high, confidence among participants in the economy will be high, and market prices will soar.

The Role of Emotion in Business Decisions

According to the theory behind animal spirits, the decisions of business leaders are based on intuition and the behavior of their competitors rather than on solid analysis. Keynes understood that in times of economic upheaval, irrational thoughts might influence people as they pursue their financial self-interests.

Keynes further posited in The General Theory that trying to estimate the future yield of various industries, companies, or activities using general knowledge and available insight “amounts to little and sometimes to nothing.” He proposed that the only way people can make decisions in an uncertain environment is if animal spirits guide them.

Animal Spirits Enter the 21st Century

In 2009, the term animal spirits returned to popularity when two economists—George A. Akerlof (Nobel laureate and professor of economics at University of California) and Robert J. Shiller (professor of economics at Yale University)—published their book, Animal Spirits: How Human Psychology Drives the Economy, and Why it Matters for Global Capitalism.

Here, the authors argue that although animal spirits are important, it is equally important that the government actively intervene to control them—via economic policymaking—when necessary. Otherwise, the authors postulate, the spirits might follow their own devices—that is, capitalism could get out of hand, and result in the kind of overindulgence that we saw in the 2008 financial crisis.

Examples of Animal Spirits

The Dotcom Bubble

Animal spirits often manifest as market psychology defined by either fear or greed. For the latter, the term “irrational exuberance” has been used to describe investor enthusiasm that drives asset prices far higher than those assets’ fundamentals justify. Simply tacking on “dotcom” to the name of a company increased its market value to extraordinary levels, with startups showing zero earnings commanding ever-higher share prices.

The crash that followed saw the Nasdaq index, which had risen five-fold between 1995 and 2000, tumble from a peak of 5,048.62 on March 10, 2000, to 1,139.90 on Oct 4, 2002, a 76.81% fall. By the end of 2001, most dot-com stocks had gone bust.

The Great Recession

Another example was the lead-up to the 2008-09 financial crisis and the Great Recession, when the markets were rife with financial innovations. Creative use of both new and existing financial products—like collateralized debt obligations (CDOs)—abounded, particularly in the housing market. Initially, this trend was thought to be positive, that is until the new financial instruments were found to be deceptive and fraudulent. At this point, investor confidence plummeted, a sell-off ensued, and the markets plunged. A clear case of animal spirits run amok.

Critiques of Animal Spirits

“Animal spirits” refers to the tendency for investment prices to rise and fall based on human emotion rather than intrinsic value. This theory, however, has been critiqued by some economists who argue that markets are nonetheless efficient and that individual irrationality washes out in the aggregate. The animal spirits thesis, like behavioral economics, essentially throws a monkey wrench into the assumptions of efficiency and rationality.

Other critics argue that bubbles are not the result of mass psychology, but are due to the over-involvement of central banks and too much regulation, which stymie economic growth and throw markets out of equilibrium. These arguments often stem from Austrian economic theory or libertarianism that asserts that large increases in the money supply (“printed” by governments) are the cause of bubbles and their ultimate demise by encouraging malinvestment.

What Is an Adjudication?

An adjudication is a legal ruling or judgment, usually final, but can also refer to the process of settling a legal case or claim through the court or justice system, such as a decree in the bankruptcy process between the defendant and the creditors.

Normally, an adjudication represents the final judgment or pronouncement in a case that will determine the course of action taken regarding the issue presented. Outside of a legal process, adjudication can also more generally refer to other formal processes of judgment or ruling that render a final decision, such as the process of validating an insurance claim.

Understanding Adjudication

Adjudication describes the legal process that helps expedite and deliver a court’s resolution regarding an issue between two parties. The result of the process is a judgment and court opinion that is legally binding. Most adjudication hearings center on disputes that involve money or nonviolent infractions and result in the distribution of rights and obligations for all parties involved.

This legal process differs from other justice-seeking or evidence-based court cases. It is instead used to settle disputes between private parties, political officials and a private party, and public bodies and public officials. In the healthcare industry, for example, adjudication can determine a carrier’s liability for monetary claims submitted by an insured person.

Adjudication Disputes

The types of disputes handled or resolved through adjudication include the following:

• Disagreements between private parties, such as single-persons, individual entities, or corporations
• Disagreements between private parties and public officials
• Disagreements between public officials and/or public bodies

Requirements for full adjudication include requisite notice to all interested parties (all legally-interested parties or those with a legal right affected by the disagreements) and an opportunity for all parties to have their evidence and arguments heard.

The Adjudication Process

Formal rules of evidence and procedure govern the process where the initiating party, or trier, gives a notice establishing the facts in controversy and defines any applicable laws. The notice also sometimes outlines the nature of the dispute between the parties and recounts where and when the dispute occurred, and the desired result based on law. However, there are no specific requirements regarding the notice of adjudication.

An adjudicator is then appointed and a notice is sent to the defending party, who responds by submitting a defense to the claim of adjudication by the plaintiff. The adjudicator gives the plaintiff and defendant a chance to present their arguments at a hearing and makes a final ruling. This is not too dissimilar from an arbitrator in an arbitration hearing settling a business dispute.

What is Arrow’s Impossibility Theorem?

Arrow’s impossibility theorem is a social-choice paradox illustrating the flaws of ranked voting systems. It states that a clear order of preferences cannot be determined while adhering to mandatory principles of fair voting procedures. Arrow’s impossibility theorem, named after economist Kenneth J. Arrow, is also known as the general impossibility theorem.

Understanding Arrow’s Impossibility Theorem

Democracy depends on people’s voices being heard. For example, when it is time for a new government to be formed, an election is called, and people head to the polls to vote. Millions of voting slips are then counted to determine who is the most popular candidate and the next elected official.

According to Arrow’s impossibility theorem, in all cases where preferences are ranked, it is impossible to formulate a social ordering without violating one of the following conditions:

• Nondictatorship: The wishes of multiple voters should be taken into consideration.
• Pareto Efficiency: Unanimous individual preferences must be respected: If every voter prefers candidate A over candidate B, candidate A should win.
• Independence of Irrelevant Alternatives: If a choice is removed, then the others’ order should not change: If candidate A ranks ahead of candidate B, candidate A should still be ahead of candidate B, even if a third candidate, candidate C, is removed from participation. 
• Unrestricted Domain: Voting must account for all individual preferences.
• Social Ordering: Each individual should be able to order the choices in any way and indicate ties.

Arrow’s impossibility theorem, part of social choice theory, an economic theory that considers whether a society can be ordered in a way that reflects individual preferences, was lauded as a major breakthrough. It went on to be widely used for analyzing problems in welfare economics. 

Example of Arrow’s Impossibility Theorem

Let’s look at an example illustrating the type of problems highlighted by Arrow’s impossibility theorem. Consider the following example, where voters are asked to rank their preference of three projects that the country’s annual tax dollars could be used for: A; B; and C. This country has 99 voters who are each asked to rank the order, from best to worst, for which of the three projects should receive the annual funding.

• 33 votes A > B > C (1/3 prefer A over B and prefer B over C)
• 33 votes B > C > A (1/3 prefer B over C and prefer C over A)
• 33 votes C > A > B (1/3 prefer C over A and prefer A over B)

Therefore,

• 66 voters prefer A over B
• 66 voters prefer B over C
• 66 voters prefer C over A

So a two-thirds majority of voters prefer A over B and B over C and C over A—a paradoxical result based on the requirement to rank order the preferences of the  three alternatives.

Arrow’s theorem indicates that if the conditions cited above in this article i.e. Non-dictatorship, Pareto efficiency, independence of irrelevant alternatives, unrestricted domain, and social ordering are to be part of the decision making criteria then it is impossible to formulate a social ordering on a problem such as indicated above without violating one of the following conditions.

History of Arrow’s Impossibility Theorem

The theorem is named after economist Kenneth J. Arrow. Arrow, who had a long teaching career at Harvard University and Stanford University, introduced the theorem in his doctoral thesis and later popularized it in his 1951 book Social Choice and Individual Values. The original paper, titled A Difficulty in the Concept of Social Welfare, earned him the Nobel Memorial Prize in Economic Sciences in 1972.

Arrow’s research has also explored the social choice theory, endogenous growth theory, collective decision making, the economics of information, and the economics of racial discrimination, among other topics.

What Is the Amsterdam Stock Exchange (AEX) .AS?

Founded in 1602, along with the creation of the Dutch East India Company (VOC), the Amsterdam Stock Exchange is considered the oldest, still-functioning stock exchange in the world.

The need for a bank grew with the prevalence of European trade and with the need to offer financiers a way to profit in this commerce. The Dutch East India Company was one of the earliest businesses to compete for the exports from the spice and slave trade. It was a joint-stock company and would offer shares to investors who would bankroll the voyages. Financiers required a safe and regulated place where buy and sell shares of these early global enterprises.

Before the AEX, many regions and towns had independent systems of asset valuation and trade regulation which operated much like stock exchanges, but the AEX was the first official stock exchange as we know it.

The Basics of the Amsterdam Stock Exchange (AEX) .AS

Over its centuries-long history, the Amsterdam Stock Exchange has gone through several ownership changes and governance structures.

Looking to recent history, in 1997 the Amsterdam Stock Exchange and the European Options Exchange (EOE) merged, and its blue-chip index was renamed AEX for “Amsterdam Exchange.”

In September 2000, the Amsterdam Stock Exchange merged with the Brussels Stock Exchange and the Paris Stock Exchange to form Euronext Amsterdam. Euronext is Europe’s largest cash equities market. For some time fell under the umbrella of NYSE Euronext, which operated several exchanges, including the New York Stock Exchange, the Liffe in London, and NYSE Arca Options. In 2014, Euronext was spun off to become an independent entity once again. As of 2017, Euronext was the sixth largest combined stock exchange by market cap.

Equity Indexes of the AEX

Euronext Amsterdam’s three broad equity indexes are the blue-chip AEX, mid-cap AMX, and small-cap AScX. By far, the most traded and influential index is the AEX, which began in 1983 and is composed of more than 20 of the most frequently traded Dutch companies which trade on Euronext Amsterdam. These companies include international businesses such as Unilever, ING Group, Philips, and Royal Dutch Shell. It is one of the leading national indices of the stock exchange group Euronext alongside Brussels’ BEL 20, Paris’s CAC 40, and Germany’s DAX.

Real World Example

Review of the composition of the AEX index is done each quarter, with a comprehensive review conducted in March and interim reviews in June, September, and December. Any changes made to the index as a result of these examinations take effect on the third Friday of the month. Before 2008, index changes were made only once annually in March.

The AEX is a market capitalization-weighted index, with initial index weightings of any one company capped at 15%. The index weights are calculated concerning the closing prices of the relevant companies on March 1. During quarterly reviews, weightings after adjustment are left as close as possible to those of the previous day and are not re-capped.