“Wishful betting can contaminate financial markets, study shows”

Researchers from The University of Texas at Austin and Cornell University demonstrated that “wishful betting” by investors may not only harm the investor, but may influence the market and could contribute to stock market bubbles and other pricing anomalies.

Wishful betting can contaminate financial markets, study shows. – EurekAlert

In the paper, “Contagion of Wishful Thinking in Markets,” researchers from The University of Texas at Austin and Cornell University demonstrate how wishful betting can contaminate beliefs throughout markets, as other market participants infer wishful bettors possess more favorable information than they do. As a consequence, investors who initially held accurate beliefs become overly optimistic about stock values. The research will be published in a forthcoming issue of Management Science.

“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.”

It would be difficult to characterize markets trading on a bubble as efficient, in my opinion, and this study seems to confirm that notion. This study appears to be at odds with Eugene Fama’s Efficient Market Hypothesis.

The study found that employees may overweight their portfolio with their own company’s stock just as citizens might favor local company stocks.

“If you are an employee of a company or a resident of a city, you have many reasons to desire that your employer or local companies will be successful,” Seybert said. “Our theory suggests that one employee’s investment could be viewed as a positive signal of value by other employees. Ultimately, employees might use this information to purchase too many shares of their employer’s stock.”

Seems to me this study is simply expressing the emotional, and sometimes illogical, behavoir of market participants and how that emotion may be contagious.

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