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Social Influences in the Stock Market - Essay Example

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When it comes to individuals investing in the stock market, many people erroneously think that investor decisions are driven by purely economic factors. While it might be logical to expect that a particular investor would calculate the fiscal strength of a company, determine a minimum return on investment, and act accordingly, research indicates otherwise…
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Social Influences in the Stock Market

Download file to see previous pages... Kenrick and Simpson (1997) maintain that "...in the stock market, people's investment decisions are determined, not by the actual value of a resource but by the perceived value" (p. 36). Once an investor moves from pure economic analysis into the area of perception, social influence becomes a key influence. By using acuity rather than data, the investor draws upon the elements that make up the perception, whether factual or not. Those perceptive elements are usually socially-derived and filtered through the individual's own bias. The investment decision is then no longer about objective fact, it is about the individual's subjective opinion-right or wrong.
The prices of securities themselves are often a function of this process. In the stock market, pricing is set by the market's consensus opinion of a company's underlying value. If more people have a good opinion of a stock's worth or potential, they will pay more for it. If the majority, however, have a negative view on a security, that outlook will express itself as a lower price. The obvious social influence here is that many of the people who are setting the price are making decisions based on their unique view of the company, market, or economy. This perception is certainly not always accurate. Shefrin states it like this, "People commit errors in the course of making decisions; and these errors cause the prices of securities to be different from what they would have been in an error-free environment" (2002: p. 6). If the majority of investors in ABC Company are influenced by an erroneous social perception, e.g., the company is not environmentally responsible, they will make their investment decisions accordingly and the price of the stock will fall. ABC Company may or may not be an industrial polluter; but if the market perceives that they are, the result is negative. In this case, perception is reality.
A dramatic example of this premise is demonstrated by observing the impact of the media on market events. For example, in October 1987, the United State's stock market crashed with a resulting massive loss in equity. In trying to understand the reasons behind the event, economist Robert Shiller sent questionnaires to active traders. What he discovered from the response was that the investors were responding to the news of the crisis, not necessarily the underlying fundamentals of the market itself (Brehm, 2005, n.p.). That day, the price movements in the market were not triggered by any objective economic information; prices were dropping because of mass investor response to the news that prices were dropping. Shiller (2000) articulates this concept very well when he observes that, while the media may represent that they are independent "...observers of market events, they are themselves an integral part of these events. Significant market events...occur only if there is similar thinking among large groups of people, and the news media are essential vehicles for the spread of ideas" (p. 71). Within the context of the modern information age; given the pervasive presence of journalists reporting, pundits opining, and bloggers ranting, it is easy to infer the significant social influence wielded upon the financial markets by the media.
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