The Joseph Effect

The Joseph Effect is a term coined by mathematician Benoit Mandelbrot. It hypothesises that movements over time tend to be part of larger trends and cycles as opposed to being random. The measure is founded on the assumption that future events are greatly influenced by past events.

Mandelbrot’s theory is based on the Old Testament story of Joseph. The Pharaoh dreamt of seven fat cows being devoured by seven lean cows. Joseph–who interpreted the dream–forecasted that after seven good years of crop harvesting, seven bad years would follow.

The hypothesis sought to express that man–and even civilisation as a whole–was attuned to the cycles in nature and wanted to become better at forecasting their economic future. Human behaviour is greatly affected by recent experience; and we have a tendency to forget the more random and disruptive lessons of the distant past.

A society’s willingness to undertake risk plays a key role in returns to assets. Even though painful and tragic market crashes occur, the memories of hardship and crisis fade over time. Optimism or greed then comes in to clear away the memories of the crashes. This, in turn, leads consumers and investors to steer the economy and stock markets into bubbles. The cycle then repeats itself again and again.

The premise behind the Joseph Effect is that future developments are strongly influenced by past developments; and this allows for a certain level of continuity and predictability.