In most of his lectures[1] [2] [3] based on the history and meaning of Behavioral Economics, Richard Thaler[4] a Nobel-winning Economist, uses the example of the CUBA Fund to highlight how financial markets are not rational.

While a single example doesn’t necessarily serve as concluding evidence against the assumption of rational markets, it does serve as a neat visualization for laymen.

The CUBA Fund is a Closed-ended mutual fund [5][6]which for our purposes means that its market value is decided by supply and demand and hence it can trade below or above the value of its constituents known as the Net Asset Value (NAV) (unlike open ended funds which are limited to the value of its constituents i.e.; NAV) further explanation of both these types can be found in footnote 5 and 6.

Here are the closing prices of CUBA Fund from May 2014 to March 2016;

Source; Behavioral Economics: Past, Present and Future p.12 (Red line extended by Author)

Let us state some basic facts we understand from this graph;

The market price (green) started at 10% lower than NAV (orange).

Remember, the market value of the fund does not have to equal the NAV i.e.: the value of its constituent assets. This is often the case with close-ended funds. This means you can buy the fund at a lower price than what is ‘really’ its price.

The market value (which was earlier 10% lower than NAV) is 70% higher than NAV on December 18th.

This means that you can sell the fund at higher than it’s constituent assets (and way higher than what you bought it at in May-Nov 2014) Thaler, in the aforementioned paper, noted — Whereas it had previously been possible to buy $100 worth of Caribbean assets for just $90, the next day those assets cost $170!

Now, how does this serve as an argument against the idea that financial markets are rational?

To understand this we must question what happened on December 18th.

On December 17–18th, Obama ended the Cuban thaw as reported below -

President Barack Obama and Cuban President Raul Castro said today they would begin normalizing relations between the two nations, a deal brokered by Pope Francis and aided by the generational shift in Florida ‘s Cuban-American community. The action means not simply the opening of a U.S. embassy in Havana but the lifting of some of the restrictions that have limited travel and commerce and kept aficionados from legally bringing Cuban cigars to U.S. soil. Obama Acts to End More Than Half-Century U.S.-Cuba Estrangement

The spike perfectly correlated with this move made by Obama. The relaxation of restrictions with Cuba made for a positive market sentiment towards the CUBA Fund hence the spike.

Except,

[The Fund] gave itself the ticker “CUBA” despite the fact that it owns no Cuban securities nor has it been legal for any US company to do business in Cuba since 1960 (although that may change at some point) ~ Thaler : Economics: Past, Present and Future( p.12)

The CUBA Fund has nothing to do with Cuba.

To a rational economic agent, the 70% boom makes no sense. There was virtually no change in the NAV. It makes no logical sense that the market value of the CUBA fund be higher with such significance.

The fact that market sentiment can be swayed with such unpredictable and irrational changes poses a big threat to the belief that financial markets are fundmantally rational.

I highly recommend watching at least one of the lectures from footnote 1, 2 or 3 and/or reading the paper by Thaler mentioned multiple times- Behavioral Economics: Past, Present and Future for further understanding of this topic.