Sunday, February 19, 2006

Are Your Interests the Only Thing Stockbrokers Care About?

In a NBER paper, the researchers find evidence that:

" An individual analyst will raise his recommendation proportionally to the recommendation that he expects from other analysts. This is intuitive. A given recommendation does not make senses in isolation, but only relative to the recommendations of other analysts. If no one else in the market is issuing recommendations of “market underperform” or “sell”, an individual analysts may give the wrong signal by issuing such a recommendation even if he believes the recommendation is literally true."

Read the paper here.

This paper is important because:

1) Some economists complain about game theory for its lack of empirical content. A good way to defend the usefulness of game theory, as a tool, is to derive implications from the model, and subject them to rigorous testing. This is what the paper does.

2) If peer pressure leads stock analysts to give similar recommendations about stocks at the same time, and buyers tend to follow analysts' advice in their stock picks, then this may very well be one of reasons for why herding behavior is observed in the stock market.

3) The result lends support to Keynes' famous analogy of the stock market as a beauty contest.

4) Further avenue for research is find out whether there is opinion leader in the stock market and if so, what helps establish the status of an opinion leader and what are the implications of such opinion leaders have for the stock market.

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