Post Financial Crisis And Investor Attitudes And Behavior
2.0 LITERATURE REVIEW
This Chapter provides a review of the literature on the investors’ behaviour, market trends along with Investors Overreaction, market seasonality and attitude towards market sentiments. Literature review is basically a study of perused data and information which is related to this research According to these reviews there are few areas in which we are able to analysis the correlation to the current study conducted by various researchers.
2.1 Investors Behaviour
This paper generally shows how the investors have been reacting all these years on the markets and what has been their view on the market trends and seasonality changes which has affected the investor the most. Currently the research is based on the investor’s behaviour and attitude on what factors make them react or induces them to invest again in the markets after the financial crisis. On being more precise there are many issue to be considered when it’s seen from investors point of view but in this paper the research is conducted on the investor’s information sources. The investors dependency level on the investor information source is tested and the behaviour of the investor after receiving the information. Similarly the risk tolerance level is also tested with investor’s age and gender.
2.1.1 Investor overconfidence
The use of attitudes and opinions are found in the behavioural finance literature to segment investors. Investor overconfidence (Barber and Odean - 2001) may be taken into account as the level of trading done by the investors in financial markets, as well as the fact that the individual investors make systematic mistakes in the way they process the information (Woods and Zaichkowsky – 2004) . The Overconfidence present in the Investor is the greatest emotion for the difficult task, of forecasting with low predictability and less information on immediate clear information. Generally investing in the stock markets is a difficult task with little knowledge of predictability and lack of feedback. In this research paper the illusion of knowledge occurs when there is all sort of information given to the investors for trading and then when the confidence analysed is improved slowly in investors’ trends. The investors believe in the online source/company reports which at times lead to overestimates.
2.1.2 Available Information
The trend of available information give more confidence to the individual the Investor who spend a considerable amount of time in collecting data will be much convinced that their actions are reasonable. Because it would be unreasonable to spend so much time gathering useless data, investors are motivated to believe their data are useful, thus resolving cognitive dissonance (Barber and Odean 2001 et la). The Investors basically follow the forecast of economic trends from the past. When the investors sense his results he will have all the memories of what he did earlier. This can be widely skewed the individuals often condense the information and behave in ways which will increase confidence. Self-attribution bias says individuals tend to attribute their successes to their personal abilities, and their failures, to bad luck or the actions of others. Individuals also tend to ignore, or at least under weigh, information that lowers their self-esteem (Daniel and Titman - 1999). As a result, investors tend to forget past failures. Psychological research shows that while both men and women exhibit overconfidence, it is generally more prevalent in men (Lundeberg, Fox, and Puncochar ). Indeed, Barber and Odean (2001) found that men trade 45% more actively than women. While both men and women reduce their returns by trading, men reduce theirs by an additional 1%.
2.1.3 Risk and uncertainty
Overconfidence cannot explain all the reasons that individual investors act "irrationally." however. Another important area of behavioural finance is the study of how individual investors deal with the elements of risk and uncertainty (Woods and Zaichkowsky – 2004). This study identifies the 6 main components on which the study revolves around these are long-term/short-term investment horizon, Stability versus volatility, Risk attitude, Personalization of loss, Confidence and Control. The study was quite complex in understanding the investors behaviour in accordance with the sampling procedure. The individual investor segments that we identified and profiled provide an opportunity for investors, financial analysts, and companies to improve investment decisions and communication. Each segment purchased different stocks, used different information, and treated their stable and volatile investments differently. (Woods and Zaichkowsky – 2004 el la).
2.1.4 Common Information
This article is based on the Investors behaviour and reaction when there is common information given to all at the same time. This article analyzes trading behaviour and equilibrium information acquisition when some investors receive common private information before others. However in this literature investors who are not informed will not condition their trades on public observables such as price flows and order flows, which is expected to be the most important sources of information about the security(Hirshleifer, Subrahmanyam and Titman -1994). More recent work has analyzed dynamic trading behaviour where the uninformed investors condition their trades on all public information (Brown and Jennings (1989), Grundy and McNichols (1989), Kim and Verrocchio (1991), and Wang (1993). These recent models provide important insights in settings where all potentially informed investors receive information (public or private) simultaneously. We find that in partially revealing rational expectations equilibrium, investors who discover information early, trade aggressively in the initial period and then partially reverse their trades in the next trading round, when the trades of the investors who become informed at this later date cause the price to more fully reflect the investors' information (Hirshleifer, Subrahmanyam and Titman -1994).
This reversal is due to the risk-averse, early-informed investors try to reduce the long-term risk related to the price movements that arise from the future events. The trades of the informed investors are consistent with certain oft-cited institutional strategies.' Specifically, the early informed appear to be short-term "profit takers" because of their position reversal. On the other hand, the late informed appear to "follow the leader" as their trades are positively correlated with those of the early informed (Hirshleifer, Subrahmanyam and Titman -1994).
According to the study in this paper all the informed investors get the information at the same time as the mass of informed investors. Prices become more informative which also decreases the value of the information. Our analysis suggests that the exact timings of when investors uncover relevant information maybe even be more important than the accuracy of the information (Hirshleifer, Subrahmanyam and Titman -1994). Generally the investors who receive the information earlier trade differently from the one who receives it late, The equilibrium in the stock markets where the investor get information before others can be different from the equilibria in models of information acquisition where the investors get their information simultaneously. (Alpert and Raiffa -1982)
2.1.5 Position Reversal
With respect to trading strategies, in our model certain investors make trades that are correlated with, but not caused by, other trades and price moves. Traders appear to follow the leader, but this is not a result of imitation (Tversky and Kahneman -1974) . Rather, followers and leaders observe a common signal at different times. Position reversal occurs not as a result of favourable price moves or public revelation of private information, but because early-informed traders wish to reduce their positions over time to avoid risk. Position reversal is correlated with favourable price moves, since on average the early informed do profit on their early positions. Thus, our model highlights the crucial distinction between correlation and causation in the analysis of institutional trading strategies (Einhorn and Hogarth -1978),
2.1.6 Before and After Correction
In this paper, the authors attempt to gain insights into the behaviour exhibited by investors before and after the market correction of the newly established Internet sector—a technology with revolutionary potential—in the Spring of 2000 by structuring their analysis around the psychological themes of heuristic-driven bias, frame dependence, and inefficient prices( Wheale and Amin -2003). In this study the linear regression models are constructed using data collected on publicly traded Internet companies and on market performance to assess correlation with certain specific measures of corporate internet performance. (Schumpeter Mowery and Rosenberg – 1999).
The researcher settles down with the suggestion that the investors’ believe that a must for the internet companies to produce revenue rather than profits and show revenue as a proxy instead of profits for market acceptance and market share. We provide evidence that there is a stronger negative correlation among the stock prices of Internet companies and their free cash flows prior to the market correction. This finding is in accordance with (Hand and King -2000), This paper explains the market price for the internet stocks bags larger losses when translated into higher stock prices, the reason being that the losses suffered will be regarded as strategic expenditure by management & not as poor performance. Internet Managers have invested a certain amount in intangible marketing in order to expand the market share faster in expectation of obtaining the profits.
2.1.7 Psychological Factors
Behavioural finance has been introduced as a valuable supplement to classical financial theory. Psychological factors were considered important inputs to investment decision making (Wheale and Amin -2003). By following this way the financial market reacts in opposition to traditional theory which seems to appear as irrational maybe explained as form let asserts, appreciation of the psychological inputs to investments decisions may assist financial managers in avoiding serious mistakes and enable them more viable investment strategies((Schumpeter Mowery and Rosenberg – 1999). In recent years the internet-enabling technologies will have great benefit among the economy & consumers in many ways to compliment that the World Wide Web rules the business which is been a big substitute. But until the global economy expands and established industrial management adopt this new technology with greater enthusiasm than hitherto we must wait for the Internet-enabling technologies to have the revolutionary transforming consequences of a ‘new technological system’. Finally, the authors draw inferences relating to the psychology of investor behaviour during this period based upon their empirical analysis, and conclude by summarizing the managerial implications of their findings (Wheale and Amin -2003).
2.2 Market Trends & Behaviour
This is a empirical study of two markets MSM’s – Mature stock markets the study have been focusing on properties of first & second moments of the stock returns and ESM’s – Emerging stock markets and their stock return behaviours.
2.2.1 Emerging & Mature Stock Markets
For both stock market groups, some of the basic features under investigation refer to stock return level dependence on own past terms (usually relating to stock return predictability), stock return volatility dependence on past return innovations and/or on own past terms (ARCH and GARCH effects, respectively), the risk-return relationship [(G)ARCH-in mean effect] and volatility persistence.(Tsouma – 2007). The empirical evidence on stock return predictability associated with this group (for various data frequencies) is strong, as is indicated by the results based on autocorrelation coefficients, variance ratios or autoregressive coefficients in the context of time-varying conditional volatility models (De Santis and Imrohoroglu 1997) ( Mecagni and Sourial, 1999). The data frequencies, several studies on stock return behaviour for MSMs confirm the existence of similar dependencies. Among these studies are (Campbell & Akgiray - 1989) for the CRSP (Centre for Research in Security Prices) index and Booth et al. (1997) for four Scandinavian indices.
This paper has followed a methodology which analysis the (AR(1)-GARCH-M (autoregressive generalized autoregressive conditional heteroskedasticity) model is used. In this applications which states the relationship between the risk and return with the issue of volatility persistence. For MSMs, some results indicate that a positive and statistically significant relation exists between risk and return (French and Chou, 1988), while other suggest a negative and statistically significant relation (Elyasiani and Mansur, 1998).According to many other study the other stock markets have different stock return levels and volatility are influenced by the stock return determination process in other stocks markets. The price and volatility transmission mechanisms examined mostly concentrate on MSMs. The related work for ESMs is limited. In general, MSMs are often characterized by one or bi-directional price and/or volatility transmission mechanisms (Rogers, 1994; Koutmos and Booth, 1995; Francis and Leachman, 1996). The evidence which is sometimes provided for ESMs (Rogers, 1994) is similar. There are findings on the existence of significant interdependencies between the stock markets all around the world. This is based on effects caused by two leading stock markets and the return determination process in quite a few Mature stock markets and Emerging stock markets. Results do not lend support to the view that stock markets function in isolation and independently. Finally, the origin of interdependence relationships should not be exclusively viewed in connection with the leading stock markets, but with ESMs as well (Tsouma – 2007)
2.2.2 Long-term stock markets
The current study of the markets is on the long-term stock markets overreaction and this study is analysed for a more than 10 -15years. Investigating all stocks listed on the Center for Research in Security Prices (CRSP) tape of authors show that over 3 to5 year holding periods stocks that performed poorly over the previous 3 to 5 years achieve higher returns than stocks that performed well over that period (Schnusenberg – 2006) According to (DeBondt and Thaler – 1985) Over the last half century, loser portfolios of 35 stocks outperform the market by, on average, 19.6% 36 months after portfolio formation. Conversely, winner portfolios earn about 5.0% less than the market, so that the difference in cumulative average returns between the extreme portfolios equals 24.6% (Schnusenberg – 2006). Other findings include a symmetric overreaction effect which is larger for the losers than the winners. Meanwhile the long-term losers outperform the long-term winners only in January and that’s because of January effect. In Recent years (Chopra – 1992) re- examine Debondt and Thaler investigate the stock returns of New York Stock Exchange (NYSE) issues from 1926 to 1986 incorporating size, prior returns, and betas in a multiple regression model. The paper talks about the lower portfolio which was formed based on the 5 year returns which outperform the winners by 5% - 10% per year in the next following 5 years. The larger portfolio returns during the January are for the smaller companies. Fama re-examines stock market efficiency in the context of stock market over- and under reaction (Fama – 1998). The researchers argue that the market efficiency faces the challenge from the finance literature. The irregularity of returns results in obvious over reaction to the information availed and is also common as under reaction. Furthermore, post-event continuation of pre-event abnormal returns is about as frequent as post-event reversal (Schnusenberg – 2006).Generally several studies have used the similar models used by Debondt and Thaler(1985) to examine short-term price movements. The portfolios are formed based on the very short term, likely to be daily, weekly or monthly for both the winners & losers. The time period and subsequent portfolios observed on the whole the overreaction hypothesis rest in a stronger majority of losers. Moreover there is also few support for the winners reversals.
Brown and Harlow (1988) investigated the OH for CRSP-listed NYSE firms from January 1946 to December 1983. Extreme price movements, defined as stocks with residual returns that gain/lose between 20 and 65% (in absolute terms) between 1 to 6 months are examined for signs of overreaction. (Schnusenberg – 2006).
The result states that there is a large price reversal for the losers. Conversely, the winners do not show any decline to the first month. In a similar vein, (Howe-1986) investigated the OH for stocks traded on the AMEX and the NYSE over the period 1963 to 1981 using weekly returns. In applying his methodology, all stocks whose returns rise or fall more than 50% within one week were investigated. Howe found strong support for the OH for both winners and losers. Specifically, winners (losers) had returns of _13.0% (13.8%) over the subsequent ten weeks. A recently heavily researched area of behavioural financial research may bring us one step closer to understanding the psychology of investors and its effects on financial markets (Schnusenberg – 2006). The study investigated the aggregate behaviour of the stock market prior & subsequent to new markets over the period of 1988-2002. There is evidence that the variance of abnormal returns in the windows surrounding new high days is significantly larger than the variance of abnormal returns over the same window on non-high days for all levels investigated. These results show the new stock market index sets the psychological barrier index for the investors, like few traders who trade cautiously when the new index approaches. The larger return variance prior and subsequent to the new high day is indicative of active buying and selling activity prior and subsequent to the new high.(Schnusenberg – 2006).
2.2.3 Market behaviour at Elections
There is another study of the market behaviour and trends during country elections. An early example was provided by (Niederhoffer, Gibbs and Bullock - 1970) who analysed the behaviour of the Dow Jones Index around 18 US Presidential elections during the years 1897- 1970, In eight out of the nine Republican victories, the market rose the day afterwards, by an average of 1,22%. By contrast, the market only rose on four occasions the day after the nine Democrat victories, and the rise was only 0.81% on average. In 12 of the 18 elections, the market rose in the week of the election. The rise averaged 2.45% and was eight times the size of the average fall. The same study was again examined by (Riley and Luksetich - 1980) who designed a trading rule to exploit the systematic market behaviour. In this study the result was more foward on the positions held by the market players like a rule of buying after the republican victory and selling 18days later or (short) selling after the democrat victory and buying back in 33days later. More Recently More Dobson and Dufrene (1993) found that the relationships between the S&P500 index and other national stock indices changed during a Presidential election period.
Similar results for the UK have been found by (Peel and Pope -1983), Using data for 1950 - 1979. They found that, on average, the market rose in the week leading up to the election. The political election is an important source of new that contain the opinion polls & this has been incorporated to some studies. But the results of these studies are mixed where Peel & Pope was not able to find out the systematic evidence or the link between the prediction of opinion polls and the observed price in the week preceding an election.
The percentage changes in the market on the day after each of the elections together indicated a statistically significant positive (negative) reaction to a Conservative (Labour) win. However, they also found that 'any patterns in the data varied from election to election", possibly hinting that trading rules could not be relied upon (Steeley – 2003). This article added to the growing literature on asset price behaviour and election results in three ways.
A variety of assets are examined, beyond the stock market and its derivative products that have featured in previous studies.
A high frequency data set is used where the asset prices are observed at five-minute intervals.
The data set covered the overnight trading period on election night itself, The impact of the sequence of results declarations until eventual victory was secured can be studied (Steeley – 2003).
The derived results were stating that in 1992 the gilt-edged market traders have produced relevant changes in the market during the election night, tied to certain election. Empirical tests confirmed that the markets were indeed responding to the unfolding political events, and showed particular sensitivity to some key results (Thompson and Ioannidis -1987). while the price reversals were seen during the night might hint at market pricing inefficiencies. When set against a broader context this seems an unfair assessment. Moreover, without contemporaneously surveying the opinions of the market participants, it is not possible to determine whether the news-induced moves established in this study reflected anything other than genuine responses to changing investor sentiment (Steeley – 2003).
2.3 Investor Overreaction and market seasonality
In the previous paper we discussed on the different investigation made by many researchers on different situation and here we are analysis the literature on investors’ overreactions & the market seasonality.
2.3.1 Decision Making
In this study the strategy is based on the notion that many investors are poor Bayesian decision makers. Experimental and survey evidence indicates that in probability revision problems people show a tendency to "overreact," i.e., they overweighed recent information and underweight base rate data. We conjectured that, as a consequence of investor overreaction to earnings, stock prices may also temporarily depart from their underlying fundamental values. With prices initially biased by either excessive optimism or pessimism, prior "losers" would be more attractive investments than prior "winners." (De Bondt and Thaler - 1987), meanwhile it is useful to look into the winner-loser effect which has been left unsolved for a long period.
There is a pronounced seasonality in the "price correction." Almost all of it occurs in the successive months of January, especially for the losers.
The correction appears to be asymmetric: after the date of portfolio formation, losers win approximately three times the amount that winners lose.
The characteristics of the firms in the extreme portfolios were not fully described. This is important since studies ( Keim and Reinganum - 1999 )
The winner – lose effect may simply be another well known subject that will be considered in distinguished size and turn of the year effects. The interpretation used as our end result which is the evidence of the investors’ overreactions has been questioned. There are at least two alternative explanations, both involving time-varying equilibrium rates of return. Using methodology similar to our own(Vermaelen and Verstringe- 1992) replicate the winner-loser anomaly for the Belgian stock market. (De Bondt and Thaler - 1987).
2.3.2 The Winner-Loser Effect, Stock Market Seasonality and Risk.
The most curious result in our previous paper is the strong seasonality in the test period returns of winners and losers. A large portion of the excess returns occurs in January. There are seasonal patterns in returns in formation period and within the extreme portfolios are there any systematic price reversals occurs throughout the year, or maybe this effect is only in January. At last the January corrections driven by recent share price movements or by more long- term factors are been analysed on these factors
Results Comparing the size & winner-lose effects.
Excess returns & Overreaction to earnings.
“A comparison of the average and median EPS makes it clear that the averages are somewhat
affected by outliers. Preliminary work suggests that there is similar cross-sectional skewness in the test period returns of securities that make up the extreme portfolios. (De Bondt and Thaler - 1987). Since the samples are selected from both the main and delisted files of COMPUSTAT, they do not suffer from "ex post selection" bias as it is normally understood in the literature (Banz and Breen 2001)
This paper has made contributions to this task in two different directions. First, two plausible explanations of the winner-loser effect, namely those based on the size or risk characteristics of the winning and losing firms, have been examined. The data do not support either of these explanations. Second, the paper provides new evidence consistent with the simple behavioral view that investors overreact to short-term earnings movements. Certainly, within the framework of the efficient market hypothesis, it is distinctly puzzling that a dramatic fall (rise) in stock prices is predictive of a subsequent rise (fall) in company-specific earnings.
As to time-varying discount rates, we certainly agree that they may play a role in explaining the observed price reversals. However, even if time-varying discount rates can be shown to offer a coherent explanation of the winner-loser effect and other anomalies, for the "market rationality hypothesis" (Merton ) to be accepted, it will also be necessary to demonstrate that these fluctuations in discount rates can be characterized as rational responses to economic conditions rather than emotional shifts in the mood of market participants.
2.3.3 Expectations and Confidence
This paper shows the expectations and confidence of the Indian investors and their importance on the financial markets in India. Previous research of investors in other countries has shown that both of these attitudes manifest clear tendencies to change through time and strongly influence the behaviour of the pragmatic markets.( Srivastava – 2006) The field of behavioural finance an emerging field in financial analysis that takes explicit account of psychological factors is the driving force of this research. Many researchers have undertaken studies on the subject. (Stiglitz and Weiss – 1981) have indicated that any bunch of new entrants into the equity market contains a number of frauds. Potential investors know this, but cannot identify the frauds. (Ritter -1991) has indicated that IPOs in the longrun are overpriced. ( Bumgarner and Prime -2000) have studied the capital flows to and from Hong Kong in the years prior to its reversion to Chinese sovereignty and during the transition.
They ( Dechow, Hutton and Sloan - 2001 ) found that analysts growth forecasts are routinely over optimistic around new equity offerings, but the most over optimistic are those analysts employed by the lead underwriters of the offerings. (Bloomfield, libby and Nelson – 1999) have indicated that less informed investors are over confidant in investments. By giving more information to the professional investors will directly harm the welfare of the less informed investors and if the less informed investors are not informed it becomes a informational disadvantage. (Statman - 2002) in his research compared the investors a century ago with investors today. He concluded that today’s investors are more rapidly informed than their predecessors, but they are neither better informed nor better behaved. (Hall - 2002) has conducted research on broker’s recommendations.
In the Indian context, (Gupta 1996) has indicated that from the angle of investor protection, the regulation of the new issue market is important for several reasons. The number of small investors in new issue market is massive. Most of new investors make their first entry into equity investments via the new issue market. So retaining common investor confidence in primary markets is important. (Madhusoodan -1997) has indicated that in the Indian stock market, higher risk is not priced, hence investment in higher risk instruments is of no use.
( Kakati 1999) has indicated that Indian IPOs are under priced in the short run and overpriced in the long run. Selling after allotment, around the listing month, is the cause of major return differences between IPOs performance in the short run and long run.
(Gokaran – 1996) has studied the financing patterns of the corporate growth in the country. The study indicated that equity markets suffer serious inadequacies as a mechanism for raising capital. (Murali 2002) has indicated that new issues market (NIM) focuses on decreasing information asymmetry, easy accessibility of capital by large sections of medium and small enterprises, national level participation in promoting efficient investments, and increasing a culture of investments in productive sector. In order that these goals are achieved, a substantial level of improvement in the regulatory standards in India at the voluntary and enforcement levels is warranted. The most crucial steps to achieve these goals would be to develop measures to strengthen the new issues market.
2.4 Attitude towards Market sentiments.
There is a certain percentage of people investing in securities have risen sharply in recent years. The decision taken by the individual investor is become more complex & risky. Basically the understanding of how the investors invest and on what factors influence them to invest or affects their financial decisions is very important.
2.4.1 Complex & risky
One reason we are seeing an increase in individuals investing in the stock market is because of the trend toward assuming responsibility for one’s own retirement income (Clark-Murphy and Soutar ). This trend has been driven by mandatory pension funds and an aging population.( Clark-Murphy et al - 2004) found that, as a result of government policy, more than 50% of Australians own shares either directly or through managed funds. However, although psychological variables were discussed for segmentation, (Wärneryd -2001) found few empirical studies available on psychological factors in securities ownership by individual investors. In this paper the researchers contribution in classifying the current and potential consumer of investment products on the basis of the psychological variable of money attitude. Risk attitudes have been studied the most. Little correlation has been found between general risk attitudes and risky investment choices by individual investors (Morse , Wärneryd ). However, there is a significant correlation between the more specific investment risk attitude that captures risk tolerance in stock investing and the riskiness of investment portfolios (Wärneryd ). This relates to the hypothesis that risk-taking is domain-specific (Weber, Blais, and Betz ).
2.4.2 Research on Money Attitude
Several scales have been developed to measure different aspects of people’s attitudes toward money (Fank , Lim , Lim and Teo , Tang , Yamauchi and Templer ). These studies suggest that money attitudes are multidimensional. Tang [1992, 1995] developed a money ethic scale, consisting of affective, cognitive, and behavioural components. Lim and Teo  developed a combined, more parsimonious scale using items from existing scales developed ( Furnham -1984], Tang , and Yamauchi and Templer - 1982). The money attitude scales used in the past did not include items related to investing. Therefore, based on existing money attitude scales, (Keller and Siegrist – 2004) developed a scale that also includes attitude toward investing in stocks and ethical perceptions of the stock market. Exploratory factor analysis and varimax rotation of the fifty-nine initial items yielded nine components:
• Attitude toward financial security.
• Attitude toward stock investing.
• Impulsive buying.
• Obsession with money.
• Perceived immorality of the stock market.
• Attitude toward gambling.
• Interest in financial matters.
• Attitude toward saving.
• Frankness about finances.
In order to analysis the money attitude the researchers have classified their sample size into 4 groups and they are Risk seekers, Open book, Self Players and Money Dummies. These investors are classified according the money attitude and their level of market exposure. Risk-seekers and safe players have a distinct affinity for money-related matters. Risk-seekers are tolerant of risk and have positive attitudes toward securities, the stock market, and gambling (Keller and Siegrist – 2006). Safe players find financial security and savings important, and they have negative attitudes toward securities, the stock market, and gambling. In accordance with their profile, more risk-seekers have investment portfolios, and they trade securities frequently.
Money dummies and open books also exhibit low risk tolerance and low interest in money matters (Keller et al – 2006). However, money dummies have a more positive attitude toward the stock market than open books. These results concur with existing studies finding that risk-tolerant individuals are more likely to own securities than risk-averse individuals. The results show that the money attitude typology has forecast value for behaviour (Keller et al – 2006).
It is said and believed that the institutional investors use concepts of style to characterise their portfolios and patterns of trade. The famous style of categorising stock appears to form the basis of asset allocation by many equity investors. To economize and to track the investors stocks they are taught to use the stocks as a combination of small number of styles factors rather than as independent entities. If investors use these factors, then tbey will formulate views and reallocation decisions across large versus small cap stocks, technology versus nontechnology stocks, value versus growth stocks (Froot and Teo – 2008).
By all the natural ways the investors buying could be based on anticipated fundamentals or sentiments. If style categories the mirror difference in fundamental exposures, changes in investor demand for styles may reflect fundamental information. As in (Kyle -1985), a group of investors buys securities from others when they anticipate positive fundamenta information, given current prices. (Delong. Shieifer, Summers, and Waldmann - 1990 and Barberis and Shieifer - 2003), noise trader buying is motivated purely by changes in sentiment.
2.4.3 Fundamentals & Sentiments
There are two main differences in the empirical predictions of these paradigms. First, price changes should be more permanent if fundamental information is responsible and more transitory if sentiment is responsible. At some horizon, rationally expected returns must become negative under the .sentiment story, since eventually, prices converge in expectation back to fundamental values. Second, in the Barberis and Shieifer (2003) model, sentiment affects relative demand, so that a shift toward positive sentiment for a particular style segment not only raises the price of that segment but also lowers the price of distant style segments (Froot and Teo – 2008). By contrast when there is a better change in the segments fundamentals which does not decrease the price of the distant style segment, until and unless their fundamentals are negatively correlated, something that is rarely observed. In this paper, we explore two main questions about style-level trading by institutional investors. First, is style trading statistically and economically important? Second, do style-level flows impact future style prices? If they do, is the impact more in keeping with the fundamental-or sentiment-driven story? In this effort, we examine three style dimensions: small/large, value/growth, and sector/ industry. (Froot and Teo – 2008).
In classical finance theory, fundamentals affect prices and flows do not. Institutional style investing is therefore uninteresting, as style flows do not affect prices. This paper challenges that view. We find strong evidence that investors reallocate more intensively across size, value/growth, and industry/sector deciles than across randomly generated deciles (Froot and Teo – 2008). The style flows have a tangible impact on future stock returns. At weekly frequencies, own-segment style flows and returns positively forecast stock returns, while distant-segment style flows and returns negatively forecast stock returns. This view is supportive of several behavioural models, particularly that of Barbehs and Shleifer (2003).
In 1980s the financial market were on the high performance and also had a series of changes within the sociology, relevant for its orientation to financial markets. The The first of these shifts is given by the rise of the new economic sociology, viewed by many as connected to the seminal articles published by the sociologists Harrison White and Mark Granovetter (White, 1981; Granovetter, 1985). Albeit in distinct ways, White and Granovetter argued that markets can and should be conceptualized not only as systems of exchange, but also as networks of social relationships. One of the consequences of maintain a healthy relationships and which in turn is provide by social networking. While Granovetter’s general argument sees relationships as external frames for economic exchanges,3 Harrison White, more radically, argued that exchanges take place within a system of existing relationships, which influence information concerning price, quality and reliability (Preda – 2007)
White’s innovation is that he integrates the notion of information into the treatment of markets as networks of social relationships (White – 2002). By sending signals to each other the Market actors will be able play key role in decision making on the products, price, and quality In order to be able to interpret such signals, producers need to share the same frame of perception. All the activities is ensured by attending business conventions, membership in the same clubs or after-work socializing. It follows from this that producers are not so much interested in knowing what consumers want as in knowing what other producers are doing Preda – 2007). It is perhaps no accident that, one year before Mark Granovetter’s article was published in the profession’s flagship journal, another article was published in the same venue, analysing the social structure of a major trading floor (Baker, 1984).
We have discussed here as the sociology of financial markets comprises a variety of approaches, some of which are subfields of economic sociology and organization studies, while some others operate at the intersection of economic sociology, social studies of science and social studies of cognition (Preda – 2007).
Reflecting upon the relevance of the sociology of financial markets, the following can be said: on a broader level, this subfield of sociology highlights both the centrality of financial markets as modern institutions and their irreducibility to mechanisms of resource allocation (Franke and Hess - 2000). The societal impact of markets has always gone beyond this, and it is sociology’s task to analyse how financial markets connect with other social institutions, how they affect people’s lives in ways other than economic and how they are perceived by the larger society. On a second, more restricted level, the sociology of financial markets can formulate insights useful not only for the history of financial economics, but also for better understanding actors’ behaviour in economic settings, as well as the elements underlying financial cognition. In this respect, there is certainly the possibility of a dialogue with behavioural finance, a possibility that has begun taking concrete shapes. While behavioural finance usually refers to laboratory- or survey based psychological studies of human behaviour, studies of financial cognition are conducted in situ and are thus able to offer additional insights. Structural analysis and neo-institutionalism provide us with valuable conceptualizations of the link between social ties and price volatility too (Preda – 2007).
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