Disclaimer: I am not a financial guru, nor does anyone fully understand how the stock market operates. This article is my thoughts on human behavior and how Kahneman’s ideas pertaining to loss aversion and Prospect Theory, contributed to the Nasdaq dropping 3% and the S&P 500 dropping 1.5%.
Yesterday, 1/27/2025, we witnessed a massive tech sector sell-off in the stock market due to the news that DeepSeek’s AI model was “on par with similar models from U.S. companies such as ChatGPT maker OpenAI, and was more cost-effective in its use of expensive Nvidia chips to train the system on troves of data” (AP News). We saw Nvidia, a giant in terms of creating graphic processing units (GPU’s), lose roughly 600 billion in market value and a 17% drop in stock price (Yahoo Finance). Various other technology companies were also affected (TSM, Broadcom, Micron Technology, etc.) by the recent developments, as well as nuclear power companies that would (and still will) power the next generation of AI products in terms of compute and electricity. In short, a lot of money was lost as investors panicked and reacted to fear caused by the potential of disrupted business models as the sitting kings of AI (OpenAI, Google, Meta, etc.) were being challenged for the throne. Essentially, a new kid on the block showed up, talked smack, and instead of acting calmly and logically, our collective System 1 took control as we feared a potential loss in territory. Investors, notorious in their herd mentality, started selling without taking a moment to think through the vitality of a product such as DeepSeek, the country in which it was created, as well as how DeepSeek was built (via the open source model from Meta) using reinforcement learning methods (RL) which potentially exploits the reward function, aka reward hacking. The purpose of this brief article is not to expound on the model’s components, but to draw attention to a great example of Kahneman’s Prospect Theory, loss aversion, and the certainty effect he so aptly describes in his book: Thinking, Fast and Slow.
Prospect Theory posits that we tend to evaluate our potential losses more heavily than comparable gains. This asymmetric response is due to the individual’s reference point in terms of how they perceive their utility, aka value, from a gain or loss. As such, the decision or scenario faced by a choice is relative to the individual’s perception (this is in contrast to the expected utility hypothesis proposed by Daniel Bernoulli). Investors, and the pressure they face to appease stakeholders, reacted to incumbent uncertainty surrounding the impact of DeepSeek’s innovation on our aforementioned tech companies. In short, investors sold shares not just because of real, tangible risks but because of their aversion to potential future losses. Kahneman’s idea of the “certainty effect” then took hold as investors chose to cash out now to avoid uncertain future failures. Then, as is common, we witnessed a classic example of herd behavior in that as prices began to drop, investors followed the crowd and further amplified the sell-off. System 1’s instinctive and emotional thinking began to further affect the market as news about DeepSeek and its potential to disrupt the AI landscape may have loomed disproportionately large in the minds of investors; availability heuristics at its finest. So, System 1 likely drove the initial panic we witnessed, while our System 2 was slower to catch up (as evident in the Nasdaq rebound of today).
In closing, let’s not forget that it was American technology that built the foundation for DeepSeek’s model to thrive. Sure, they used some interesting techniques that can be learned from, but the overreaction of our stock market yesterday could have been avoided had more thought been placed into the (more than likely) intention of China’s main goal of disrupting our economy. And, like Lucy pulling the football from Charlie Brown, we did exactly as they most likely predicted. Our prior announcement of a US AI investment and DeepSeek’s launch on inauguration day is not a coincidence. It was a timed response that signified to both nations the growing AI race and, more importantly, the need for the US to be the first to obtain Artificial General Intelligence (AGI). The world is taking notice of an AI driven future, and it is imperative that we do not yield to System 1’s impulsive nature. Thoughtful decision making is needed as yesterday was the official start of a free world race.
Learning Technologies 