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BEHAVIOURAL RESEARCH

Trust, News and the Efficient Markets Hypothesis. BEHAVIOURAL RESEARCH. Fairness, Trust and Emotions 1 July 2010 Behavioural Finance Working Group Cass Business School. Efficient markets hypothesis. Bachelier (1900), Samuelson (1965), Fama (1970)

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BEHAVIOURAL RESEARCH

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  1. Trust, News and the Efficient Markets Hypothesis BEHAVIOURAL RESEARCH Fairness, Trust and Emotions 1 July 2010 Behavioural Finance Working Group Cass Business School

  2. Efficient markets hypothesis • Bachelier (1900), Samuelson (1965), Fama (1970) • Prices in an efficient market reflect all publicly available information • In strong form, prices reflect all information • So what is information?

  3. What is information? • Is this information? • “IBM profits in 2011 will be $15.1 billion” • How about this: • “General Electric’s profits in 2006 were $20.9 billion” • That was “information” until profits were restated • It depends on the source...

  4. An extended model of information • We model beliefs instead of information • A belief: • is held by an agent • has a source • expresses the relative value of two goods (typically money and a financial instrument) • has a confidence level

  5. For instance • Jim Cramer told me that Intel stock is worth $28 • I place a confidence level of 5% in this belief

  6. On the other hand... • Google Finance tells me that Intel stock is worth $21.22 • I place a confidence level of 70% in this belief

  7. How do I integrate these beliefs? • I could just weight the confidence levels and produce an average valuation • Or I could go with the most trusted source • Other integration functions are available

  8. Confidence-weighted integration • Leads to smooth behaviour • Small changes in trust or value result in small changes in price

  9. Most-trusted integration • Leads to volatility • A small change in trust can result in a big jump in valuation

  10. Simulation 1 • Integration by weighted probability

  11. Simulation 2 • Integration by most trusted source

  12. Manipulation test • We specified one agent as a “promoter” of a higher price • We give them a one-off boost of 0.05 to trust, representing an investment in their reputation • Average price of stock is increased by 16% • In many plausible scenarios it is more worthwhile to invest in reputation than in fundamentals

  13. Other variations in model • Trust in some agents depends on trust in other agents • Leads to extreme volatility • Merged integration functions • Leads to more realistic medium volatility

  14. So what? • Regulators ought to be aware of the value of manipulating trust • Model implies that agents will overinvest in the structures of the market itself compared with investment in productive assets • Future research directions: • Multi-good markets • Inference of beliefs from market prices

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