Author: YUEN Wai Pong Raymond
This paper discusses a possible turf of research on behavioral finance that could be named as expert referencing.
Body of Article
However, the coverage of expert opinion on the irrational behavior of investing public is no much from the literature review in the later part of this thesis, one of the leaders is Robert Shiller of Yale University and this paper try to complement the research of (Shiller, 2001) based on the context of Hong Kong on this under-research turf of behavioral finance. Furthermore, related research in sentiment analysis (Barberis, Shleifer, and Vishny, 1998), and contrarian investment strategy developed by practitioners and academics could be regarded as an extension of expert opinion research on behavioral finance.
This is because, usually under the herd instinct of human beings, sentiment and market last mile movement of the peak or trough is pushed to some extent by expert opinion which cause the last batch of power of buying and pushing up or selling and suppressing the market is exhausted. The sentiment analysis and contrarian investment strategy work the reverse way to these expert opinions in order to gain in the market when the last batch of power is exhausted.
Direct quote from Wikipedia on contrarian investing listed on 14 May 2012, "Contrarians are attempting to exploit some of the principles of behavioral finance, and there is significant overlap between these fields. For example, studies in behavioral finance have demonstrated that investors as a group tend to overweight recent trends when predicting the future; a poorly-performing stock will remain bad, and a strong performer will remain strong. This lends credence to the contrarian's belief that investments may drop "too low" during periods of negative news, due to incorrect assumptions by other investors, regarding the long-term prospects for the company."
Within behavioral finance (Tversky and Kahneman, 1974), there is a rather under-researched area which this paper names as expert referencing. The main espouse of expert referencing is that sometime the irrational behavior of investors is because of the opinion and comment of the market expert (Shiller, 2001). We will try to gauge the extent that the degree of influence of expert opinion on investors in this research.
A lot of experts in fact are excellent in the field and with superb and detailed research and analysis about the market. Their contribution to the field is unquestionable and affirmative. Their advanced researching tools render the experts have very good insight about the market. However, the problem lies with too many people follow the recommendation of the experts and renders "momentum fatigue" caused by subjective probability (Wright & Ayton, 1994) which is a phenomenon that too many investors are investing in the same direction due to the expert opinion and render the case that after the recommendation and raise the market sentiment (Barberis, Shleifer, and Vishny, 1998), not much buying force are available for the market. This renders the "last mile" effect on the market. Then, any news and fears to the contrary will render a "regime switch".
Another possible reason of the suboptimal performance of following the opinion of the expert could be the reason given by Mr. Peter Lynch. In the example about leggings selling, some of the investment experts may only pay attention to an investment opportunity only when the opportunity starts to get wider attention and become a significant phenomenon in the market (Lynch and Rothchild, 2000). As a result, when they take the initiative of research on it, this may be a bit late and could be an over-play already. This part could be a good research topic for future to measure the extent of a new investment idea start to get attention of equity researchers.
The third possible reason could be the loss aversion of the expert. When the market rally, it is quite difficult for individual expert to give an opinion different from the opinion of the majority and the market. If they do give opinion contrary to the opinion of the majority and the market, the consequence of their opinion, if different from the market, may give them a bad impression in the industry. However, as we all know, it is better to fail together with the market instead of being the only one to fail (Armstrong and Vashishtha, 2012). If the expert fails alone, the cost of failure is much higher. If the expert fails together with the market, the consequence to the investment expert will be less detrimental. This renders the expert to give advice in the form of more trend following.
Additionally, this research further hypothesizes that investors listening to the market experts and action tend to have an unsatisfactory investment performance. This deduction is from the fact that expert opinion tends to raise the sentiment in the market (Barberis, Shleifer, and Vishny, 1998) and the last force of the investing money will be pumped into the market and renders exhausting of buying power. As a result, the further rally of the market is unlikely or even the collapse of the market is possible when investors start to divest after a disappointing performance afterward. Though the expert opinion may render the sub-optimal investment performance, the expert opinions are with very strong research base and fundamental factor to support. However, because of this "last mile" effect, the resulting performance may not be that good.
In fact, value investing (Graham and Dodd, 1934), a very good investment theory and the book is regarded as the bible of fundamental analysis, also suffers similar predicament in the EURO debt crisis. Though the market PE of Hong Kong stock is just around 14-15x before the collapse with level around 24000 which is just the average of the market PE of Hong Kong stock market since Hang Seng Index being kept track, the market still collapsed drastically to 19000 level in a little bit more than one year. By value investing theory, this is a very attractive investment but your performance telling you a different story. This could be because value investing is practiced too broadly by the investors and renders a neutralizing effect on the ability of value investing to generate alpha. For instance, in the old days, usual stock crash happened within around 3 months to 6 months and then good investment opportunities become possible. However, recent drop started in Aug 2010 and until now was more than one and a half years. This could be because too many people practicing value investing and they invested when the market looked cheap and continued to invest and render a support force for the market instead of collapsing in 3 to 6 months, the falling streak last for more than one and a half years and continued.
Similar situation also happens to wave theory, relative strength index, candle stick method (Nison, 2001) …. Those gave superior return to the one who first used them but lost their alpha generating ability when a lot of people are using them. Their investing theory and methods become the market itself and nobody can out-perform the market by these methods.
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