The research entitled “Influence of News on Rational Decision Making by Financial Market Investors” has established that business news contributes a ripple in investors’ minds to make predictions. The publication authored by Shantha Gowri B. and Vedantam Seetha Ram aimed to understand and review the individual investors’ decision-making in the stock market as well as identify the impact of different types of news on them.
Investors have, over the years, resorted to news relevant to their portfolio to increase or decrease their positions, hence, the need to conduct thorough research to find any proof of impact.
The research discloses that investors only give attention to business news about their portfolio or investment strategy. Also, the attention of investors is based on the information content and influence.
Regardless of people’s sensitivity to news, they tend to underreact when the information is favorable, certain, and public.
The research also added that investors overreact when there is favorable, uncertain, and private information. The report mentioned that the release of a news item sometimes affects only a particular stock or sector.
“The news acts as a stimulus the investor encodes, decodes, reacts and after evaluating the investors makes his decisions based on how strong is the influence of news released,” said the researchers.
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How Investors Receive Business News
It was mentioned that when business news received by investors has a greater impact on them, they overreact and underreact based on how it impacts their current situation. If the information received is undermined or ignored, its subjected to selective attention or inattention. The limited investors’ attention to the aired business news then causes underreaction. This, according to the researchers, marks the first information filtering process.
The second stage of the information filtering process is called “heuristics, bias filter, and customized filter.” Investors use this as a result of “cognitive inefficiency and limited resources of time and knowledge to process loads of information by cognitive and emotional processing, thus attributing the heuristics filter as the reason for investor’s behavioral reaction and biased decisions made”.
After this stage, the gathered information becomes perceived information upon which investors execute their decision-making. The decision-making is filtered based on each person’s financial objective, investment strategies, proficiency, and personal background.
In this case, it was observed that the market behavior usually depends on how each investor perceives the business news and how they react and make decisions under certain conditions.
The research paper also observed that market news always has the edge over corporate news as researchers are usually vulnerable to recency, availability, and representativeness bias. Recent news conflicting with the assumption of Investors and developing cognitive dissonance in their minds is underreacted. Corporate news, on the hand, also makes investors underreact to “initial public offerings, earnings announcement, quarterly statements and repurchase of growth stocks”.
“This is because reference point being set in their mind due to anchoring bias effect, overreact to analyst opinion, dividend omission, earnings, value stocks and goodwill write-offs due to availability and representative bias,” according to the research.
Investors Unable to Differentiate False Reversal from Pullback Situations
According to the researchers, the fluctuation of the stock market is in line with the macroeconomic market and company news. Therefore, they concluded that the decision largely depends on the degree of information penetration via the known filters and the degree of the information impacts.
In addition, the information that influences investment goals and strategies is another huge factor in making decisions. It further admits that an exceptional case needs to be answered by linkages of behavioral theories.
It was observed that price reversal could not be determined before time, though it benefits investors in terms of gains and avoidance of loss. This is because of their inability to determine whether the reversal is a false one or a pullback situation.
“Japanese studies have examined alpha momentum and found that there is a need to attribute the momentum in return and reversal behavior to behavioral theories,” said the researchers.
One important discovery was that macroeconomic and market news impact is uncontrollable. However, corporate news can be controlled.
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