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Impact of collective influences on forecast and investment decisions

The valuation of financial assets, by financial analysts and the investment decisions of fund managers, depend on the paradigm of economic rationalisation. Theoretical models and the tools used allow one to determine the "fair" price of financial assets

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However, it is clear that there are uncertainties and instabilities which have characterised the financial market for several years, provoking therefore, extreme volatility and a process of contagion of beliefs and opinions.

The neoclassical financial theory bases its predictions on the perfect rationality of the market players. The latter integrate all new information with their prior beliefs according to the Bayes probability theorem [1]. Individuals therefore have the objective capability to evaluate the decision-making context according to the maximisation of preferences, in agreement with Savage’s (1954) theory of utility [2]. We must remember that the condition of efficiency comes from the program of maximising the utility that the player has. The actual representation of rational behaviour is homo oeconomicus, in other words a rational individual whose behaviour aims for efficiency and satisfaction within given resources and constraints.

However, given the facts, the foundations of the classical theory approach are challenged in that they do not truthfully reflect reality. The phenomena of anomalies (deviation from the standard) and behavioural bias weaken, even further, the credibility of the doctrines of the rationality axiom and the hypothesis of efficiency. The understanding and relevance of these theoretical models means delving into the perceptions and actual motivation of the people who practice it. This would enable one to understand the reactions and the behavior of the players in a dynamic financial market composed of individuals and different challenges.

Financial analysts and fund managers try to anticipate the reactions of the Markets and therefore the anticipations on which the markets are based, thus not questioning the rationality of their approach (self-referential logic).
Abdelouahid Assaïdi

In fact, since 1936, Keynes [3] has been saying that economic rationality, in its objectivist dimension, seems inadequate to the functioning of the stock market. The latter is certainly not an area frequented by a lone individual who is in possession of all the necessary elements needed to maximise his utility and completely satisfy his own needs, but in reality, is the place where a multitude of players meet with different concerns and diverse aims.
In light of this fact, the fund manager’s decision making and the financial analysts’ forecasts do not only depend on exogenous variables, emanating from the real economy, but equally and to a large extent, it is the endogenous variables that this very same market produces, on which they rely. They try to anticipate the reactions of the Markets and therefore the anticipations on which the markets are based, thus not questioning the rationality of their approach (self-referential logic)

Our exploratory study carried out on the Parisian financial markets, among financial analysts and fund managers, actually show the predominance of mimetic processes and autofreferentials [4]. The diversity of actors in the financial markets would logically imply some interaction between them and these collective influences are such that the decisions taken are not only within individual situation, but depend largely on the assembly of the other operators.

The financial analysts and fund managers work under the authority of the market, interacting with multiple other groups of individuals with whom they are in daily contact for their forecasting and/ or investment decision making. According to this statement,it should be stressed that, in this environment, - the financial market, it is not only a question of transactions carried out individually, but also an environment where opinions and beliefs and collective knowledge exist to form the consensus. In other words, a norm instantaneously accessible to all analysts and managers who pay particular attention to it.

This norm is actually a convenient starting point which polarises the beliefs and influences the opinions of the users. If you do not conform, you risk, certainly not benefitting from the potential gains of the markets, but you also risk having to account for it to the hierarchy and above all to the clientele which does not necessarily appreciate the variations from the norm.
From all the evidence, the normative and informational influences do not mean that one must copy blindly the opinion of the majority at any one time, but, on the contrary, one must act in accordance with the environment in which the players operate.

The field research equally shows, that in a situation of uncertainty, the players on the market are not capable of giving an objective "fair" value to the asset evaluated. The reason given is that the diversity of opinion on the financial market takes into account strategic relationships between the actors. Each one attempts, therefore, not to determine what the fundamental value is, but more to determine what the market thinks the real value is. The fundamental value emerges from interaction between the players. This shows that analysts and fund managers try, not only to follow a collective opinion, but equally to anticipate the way in which the others forecast the market. The beliefs of the players, even if sometimes with no link to underlying principles, can, nonetheless, materialise on the market as soon as they are shared among intervening parties.

The normative and informational influences do not mean that one must copy blindly the opinion of the majority at any one time, but, on the contrary, one must act in accordance with the environment in which the players operate
Abdelouahid Assaïdi

Contrary to purely statistical models, the qualitative dimension of this study allows us to better understand the reality of the landscape and to appreciate, from close up, the decision-making process of financial analysts and fund managers. The interactional dynamic causes, initially divergent opinions,to converge towards a focal point representing the value of the market. In questioning, the analysts and fund managers choose to abandon their basic information in a systematic manner in order to follow the opinion of others.

However, certain of them are not able to share the same beliefs as the rest of their colleagues and at any given time, may take a decision which goes against the majority of the decisions. These are the opposers. Moreover, many of the analysts and fund managers we met through the study, were quite happy to say that they do not hesitate in going against the majority opinion when their opinion is justified by the fundamentals of defending themselves from all minemtic behaviour. They have, as such, the ability to change their beliefs because they knew how to achieve original performances or benefit from a good position. This privilege only applies to a few : the opinion leaders. It is the latter who often unify the actions of others, orientate the consensus and the opinions and in addition are the originators of new norms or conventions. This dynamism of collective opinions prove that these agreements are not set in stone. They are built up and broken down according to these interactions and beliefs in this agreement.

The shocks on the global financial markets, provoked by a worrying and vulnerable economic and financial situation, encourage consensual pessimism, capable of feeding and provoking a systemic crisis.

Abdelouahid Assaïdi November 2011

Article also available in : English EN | français FR


[1] Method of calculating probabilities a posteriori based on the probabilities, a priori (Bayes rule or inverse probabilities method) which says : in the case of a certain event and the (bi) of mutually exclusive events making a complete list of possible states of the world, then one knows that P (bi/a) =[p (a/bi)p (bi)] ?p (a/bi)p(bi)]. This formula allows a link between the probabilities a priori to probabilities based on known information.

[2] Savage L.J., (1954), « The Foundation of Statistics », Norfolk Wiley.

[3] Keynes (1936), "General Theory of Utility and Interest"

[4] Assaïdi A., (2009), « La formation des recommandations des analystes financiers et la prise de décision des gérants de portefeuille : le rôle de la rationalité mimétique »

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