E-Book, Englisch, 85 Seiten
ISBN: 978-3-640-36845-7
Verlag: GRIN Publishing
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B. Role of information in capital markets and price influence
Information being the price-governing factor on capital markets, the principles of its distribution and absorption are the key to its efficient functioning. Therefore, any rules and regulations concerned with capital market efficiency should thrive to incorporate the key concepts of capital markets, as “the findings of capital market research have severe implications for a sensible definition of the liability for information”[4]. Thus, in the following, the most common scholarly concepts are detailed. a. Efficient capital market hypothesis
The efficient capital market hypothesis, developed by E. Fama in the 1970s, claims that share prices at any time reflect available information[5], whereas three forms exist: According to the strong form, security prices reflect all information, public or not, whereas the semi-strong form would agree only as to already public news[6]. The weak form at last claims that share prices only contain past, but not actual and future information[7]. The information analysis and thus its incorporation in the prices are effectuated by professional traders, who constantly gather information and react on it[8]. This advantage in information provides them with above-average gains, and those gains, vice versa, provide an incentive for further gathering of information[9]. Nevertheless, it must be underlined that those above-average gains are not made “at the expense of the general investing public, [but] are incentive and adequate compensation for the effort undertaken in the interest of all market participants”[10], i.e. correct market prices which reflect the true value of a share with all information incorporated. Due to the work of professional traders, individual investors in small shares can rely on the correctness of prices. They do not need to costly gather information and can be simple “price takers”[11]. Empirical studies have proven both the content of the efficient capital market hypothesis and the enormously short amount of time (only several minutes) after which a piece of information becomes incorporated[12]. Nevertheless, the concept has as well been criticized: At first, we must keep mind the so-called efficient capital market hypothesis paradox: if too many investors believe the share price to incorporate all information available and rely on it, market prices cease to incorporate all information as too few investors gather it, and vice versa. If only few investors rely on price integrity, the efficient capital market hypothesis works, as investors gather avidly information to reach an insider status which allows them to make gains. Furthermore, the efficient capital market hypothesis is contested by the fact that insider knowledge actually does exist and can be used by some individual to reap extraordinary benefits, whereas according to the efficient capital market hypothesis in its strong version, it must be expected that all information is incorporated in the price. This is even more pertinent as insiders might play with the market mechanism to enhance gains. Thus, we might negate at least the strong form of the efficient capital market hypothesis. Thus, related to ad-hoc disclosure, the Efficient capital market hypothesis teaches us that sooner (strong form) or later (semi-strong or weak form) the disclosed piece of information will be contained in the stock prices. b. Behavioral finance
Behavioral finance takes on opposite view on capital markets and claims that “individual psychology affects prices”[13], whereas the concept is based on the observation that individuals do not “maximize the expected value of a utility function”[14], but modify such rational considerations with psychological behaviors. i. Information traders and noise traders
According to the behavioral finance models, share traders are two-fold: information traders “use a […] learning rule to form estimates of returns”[15], whereas noise traders act without such rules and thus generate errors. Behavioral finance argues that in a market fully composed by information traders, the Efficient capital market hypothesis would be true, while it fails in all other (and thus all real) markets[16]. Whereas the efficient market possesses a key single driver who would change prices, i.e. new information, an inefficient market where noise traders participate displays a second driver, i.e. behavior, which drives prices away from efficiency[17]. Thus, “noise traders do not process information rationally”[18] – a most valuable conclusion. As we must assume that most individual investors are such noise traders due to their lacking experience and lacking means of efficient information processing, we can expect that they will over- or underestimate information given, or mismap probabilities of its occurrence[19] due to their “particular cognitive errors”[20]. Those are sustained by so-called “bounded rationality”, i.e. the fact that the human being is only able to absorb a certain amount of information[21]. Thus, everyone would, if they were given the same piece of information, derive the conclusion which fits with their general assumptions and beliefs derived by recent history[22] regardless of the content of the information. ii. Publications effects
Experiments suggest that the form in which information is presented influences investors’ behavior, and thus eventually share prices: performance information “is valued more when it is explicitly recognized, […] and perceptions also depend on how items are grouped”[23] or whether they are included in the disclosure’s main part or as footmarks only. Thus, we must conclude that the way ad-hoc disclosure is published influences strongly its impact. Empirical evidence suggests that even “irrelevant, redundant or old news affect security prices”[24] if published in a way which provokes investor’ reactions. Thus, it must be a clear goal of regulation to define the form in which ad-hoc disclosure must be made in order to avoid overreactions by the investing public. iii. Ease-of-processing effects
We must acknowledge that every individual only possesses “limited attention, memory and processing capacities”[25] for the evaluation of information given. Thus, an overflow of information would “trigger associations that influence judgments”[26] – exactly what happened in ad-hoc disclosure. Several pieces of positive news, be it of the same or related issuers, caused investors to judge the market segment or the issuer as a whole (although this was not inferred by the individual ad-hoc disclosures) – and this judgment was, necessarily, wrong, as it was based on faulty assumptions. Such a process is heavily supported by “salience and availability effects”[27], i.e. the fact that ad-hoc information differs heavily from formerly know information and contains events of the normal course of business, which are recalled more easily. The most severe influence, nevertheless, is the so-called “illusion of the truth”[28]: people will infer the truth of a statement if it is easy to process. As the ease of processing is a prescription for ad-hoc disclosure[29], investors will infer truth for each and every disclosure and not spend the necessary critical attention to determine whether it indeed is. This is reinforced by the phenomena of “cue competition”[30], which describes the fact that salient cues weaken the effect of less salient ones, and of confirmatory bias, which means that “people are often too inattentive to new information contradicting their hypotheses”[31], or even misread adverse evidence as support for their initial hypothesis. Thus, although defective ad-hoc disclosure has been corrected, its effect might remain, as investors continue to trust in it. iv. Bounded willpower and emotional influences
Both concepts offer an explanation for the mass reactions to news: people tend to conclude “that the probability of an event […] is greater if they have recently witnessed an occurrence of the event”[32] – if, then, a sufficient amount of investors would have reaped benefits while investing in share x, they themselves would believe in its profitability regardless of contradicting signs. Such a structure will be nourished by “bounded willpower”[33], i.e. the fact that people do for short-term well-being even things which are in conflict with their long-term aims. Applied to the share market, this means: even if investors know that they run a higher risk to their long-term goal of financial security, they will...
