The Cramer Effect
Explained
By Aidan Slovinski | March 2021
Published in The Crow in May 2021 under the title The Madness of Mad Money
Mad Money with Jim Cramer airs on CNBC almost every weeknight to an audience of approximately a quarter of a million people. Throughout the course of the show, Cramer predicts market events ranging from overall trends to the futures of individual stocks. Cramer is often very explicit in his predictions; he doesn’t treat them as predictions, instead he states them as fact, like a prophet with anger management issues. As his manifesto declares: “for years [he has] been trying to help people…who own stocks and feel like they're on the outside looking in, become better investors.” Mad Money is a show marketed to amateur investors and those looking to make a quick buck. Unsurprisingly, considering the target market, Cramer’s recommendations and ruthless smashing of buttons have a significant effect on the market in the day immediately after each episode of his show.
A study from Northwestern University in 2006 entitled “Is the Market Mad? Evidence from Mad Money” found an average gain of 5.19% for the stocks Cramer endorsed in the day immediately following the airing of the show. Although the Northwestern study confirms the existence of a “Cramer bounce,” it leaves much to be desired in terms of analysis. Why exactly does the Cramer Effect occur?
From a behavioral economics perspective, the Cramer Effect is easily explained. People are naturally inclined to listen to authority. In the 1960s, Yale University psychologist Stanley Milgram demonstrated this in the famous Milgram Experiment. Milgram wanted to examine if the reason many Nazi officials gave for their actions, that they were “just following orders,” was an excuse or a legitimate psychological phenomena. To do so, he placed fellow researchers as “victims,” and ordered participants (who had no prior knowledge of the experiment) to shock them by turning the dial on electric shock generators up to a 450 volt marking (which would be likely fatal). The experiment, of course, was fake -- the “victims” were acting, and not actually being electrocuted. Curiously, Milgram found that 65% of participants raised the dial to the lethal dose after being prompted, and all of the participants raised the shock levels up to 300 volts. Milgram’s conclusion was that humanity has an innate desire to obey authority figures. Recently, the human need to obey authority has been more precisely quantified. In 2006, a study was published in Experimental Economics, a leading economics journal, which details how people even forgo financial gain to obey a perceived authority. The researchers suggested that participants pay a tax, making it clear that there would be no downside to not paying it. In other words, they didn’t have to pay the tax unless they wanted to. Astonishingly, the participants irrationally paid the tax. People have a deep desire to obey authority figures that transcends even financial interest.
Social proof persuasion is another major factor behind Cramer’s influence. Social proof persuasion is a fancy term for peer influence. For instance, if someone is searching for a new book to read, they often check the “new and notables” section, relying on the bookstore staff to choose a book for them. Similarly, if a product is highly reviewed on Amazon, people are more willing to buy it. When people are uncertain, they often look towards an authority for subtle guidance. Social proof persuasion is used by marketers to establish trust in a product. They generally do this by utilizing respected authority figures. For example, Depop, a thrifting/fashion website, often pays celebrity influencers to wear their logo or participate in ads for the platform. Depop is niche, and needs consumer trust just as much as any online retailer. Buyers have to trust that they will actually receive the product from the seller. By utilizing celebrity power, Depop is able to artificially garner trust in their platform. Mad Money has an influence on the market because people irrationally trust Cramer’s picks. Many people simply assume that because he has a financial show on CNBC, he is competent. Though he is wrong more often than he is right (his fund doesn’t even beat the market average), his position as an authority figure in finance (to the masses, at least) and his authoritative tone influence many to follow his advice.
Interestingly, the stocks that Cramer disses often see little movement. This can be attributed to the endowment effect, a term coined by psychologists Danny Kahneman and Amos Tversky. The endowment effect states that people have a greater attachment to what they already own. For example, imagine you had a very nice shell, and someone asked how much you would sell it for. Think of that price, and then think how much you would be willing to spend to buy the shell if you had never had it from the start. Kahneman and Tversky found that many people would demand higher prices to sell the shell than they would be willing to pay to buy it. In other words, people irrationally value their possessions (and the stocks in their portfolio) higher than they value what they do not have. Thus, although people may trust Cramer enough to buy based on his advice, they assume they know better when it comes to the stocks they’ve already bought. To sum it up, people are less likely to sell on Cramer’s word than they are to buy on his recommendation.
Despite Cramer’s horrific success rate, hundreds of thousands of people buy on his recommendation. Traditional economics operates on the assumption that the average person is a logical creature; Milton Friedman even went so far as to assume that people would consider how a minuscule tax break would factor into their budget for the rest of their lives. Jim Cramer is one of the best examples of behavioral economics at work. Thousands of investors fall victim to a desire to obey authority and social proof persuasion as they toss their money into garbage stocks, Jim Cramer and Mad Money egging them on.
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