Wishful betting can be contagious in financial markets

March 12th, 2009 - 4:24 pm ICT by ANI  

Washington, Mar 12 (ANI): Wishful bettors, who make overly optimistic investments, not only harm themselves financially but contaminate the entire markets as well, say researchers.

The research team from the University of Texas at Austin and Cornell University showed how wishful betting could harm beliefs throughout markets, as other market participants assume that wishful bettors possess more favourable information than they do.

As a result, investors who initially held accurate beliefs become overly optimistic about stock values.

“The findings of our studies contradict what many people assume about markets, that wishful thinkers will be identified and disciplined by more sophisticated investors,” said Nicholas Seybert, an assistant professor of finance at the McCombs School of Business at The University of Texas at Austin.

“Instead, investors fail to recognize the existence of wishful betting even though most of them do it. As a result, wishful thinking can be contagious in financial markets,” he added.

Seybert and co-author Robert Bloomfield, a professor of management and accounting at Cornell’’s Johnson Graduate School of Management sought to determine whether investors with accurate beliefs about intrinsic stock values would invest in accordance with those beliefs.

“Our research sounds a note of caution to those who assume that market prices are always a sound basis for drawing conclusions about fundamentals, said Bloomfield.

Traders in our study observe price movements driven by what Keynes called ”animal spirits,” conclude that those price movements actually reflect news, and end up exacerbating market swings by their own responses.

The cure lies in encouraging investors to engage in more fundamental analysis, rather than in outsourcing that analysis to the market,” he added.

The researchers believe that this contagion problem could contribute to stock market bubbles as well as other market anomalies.

The research will be published in a forthcoming issue of Management Science. (ANI)

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