Do Rational People Buy Overpriced Things?

Jeff Heuer has a great blog called Micromotives– The Science & Art of Decision Making. A recent post ponders “Would it ever be rational to buy something you know to be overpriced?” Jeff writes that “Research on hedge fund trading during the dot com bubble suggests the answer is yes.” Certain investors made lots of money speculating on stocks that the investors themselves believed were overpriced compared to the intrinsic worth of the company, whatever “intrinsic worth” means. The post is worth reading, and my nitpicking is not about the investing aspect, but rather the leading question (which is what caused an alert reader to send the story in the first place).

Is it rational to trade something of greater value for something of lesser value? No. So what were those investors doing? Some were simply lucky. Some lost their shirts. But some made rational decisions to buy overpriced stocks. Why? Because they weren’t buying a stake in a company, they were buying the ability to sell that stock to someone else at a higher price.

Value is not about what you’re selling. It’s about what your customers are buying.

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