NEW CONKERS3 FEATURE : The Analytical Surveyor

Analytical Surveyor has worked for over 40 years in the City and West End of London as a real estate investment manager, an equity analyst, a multi-manager, a fund manager and as a researcher and strategist. In his area of expertise, he is highly regarded and currently works as a consultant.
There is an enormous amount of academic research that provides insights into the functioning of investment markets. Rarely will this help with stock selection, but much of it will help in understanding how and why the market functions the way it does. The Analytical Surveyor trawls through the work that is available in the public domain and summarises the work into useable notes for investors.

The effect of false news on stock prices:

As a reader of news and analysis on financial-investment websites and, most likely, an investor in stocks, you probably have an interest in knowing what effect freely-available internet market commentary is having on share prices.  A recent academic paper[1] examines the dual role of social media in spreading crowd wisdom (i.e., social media aids price discovery by facilitating the aggregation of information), and rumour mill (i.e., social media hinders price discovery by facilitating the spreading of false information).

The authors focus on highly speculative reported news is, i.e., merger rumours, where the vast majority of the rumours do not materialize. They find that in the presence of likely false rumours, the rumour mill effect appears to dominate the crowd wisdom effect.

The research finds that that falsely-rumoured targets with greater Twitter volumes experience higher rumour-period abnormal returns. In addition, while rumoured targets with low tweeting volume experience a complete reversal within two weeks of the rumour, those with high tweet volume fail to reverse even after eight weeks. This is consistent with social media perpetuating and broadening the circulation of false rumours which, they argue with some justification, distorts and impedes price discovery.

There appears, therefore, to be a ‘band-wagon’ effect, with the potential for investors to produce outperformance from the combination of rumours and high-volume tweeting for a reasonably-substantial period.

Not surprisingly, for the falsely rumoured target firms, the relationship between high social media activity and distorted price discovery is more pronounced among those firms with low institutional holdings and for rumours that appear to be credible, regardless of the eventual reality.

Interestingly, the authors find evidence that rumour-period user tweeting volume is negatively related to the accuracy of a merger rumour, i.e., whether a merger rumour coming true within a year.  More fundamentally-driven investors may therefore take the combination of take-over rumours and high-volume tweeting as being a selling opportunity or signal.

The authors conclude that the evidence highlights a dark side of social media, i.e., it facilitates the spreading of the false information and distorts the price-discovery process in the capital markets.  In the coming era, that of MIFID II, in which more-formal research will be restricted to those who pay, and will be limited in volume, this situation is only likely to become worse.

[1] https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2999956

Crowd Wisdom Or Rumor Mill? The Dual Role of Social Media in Financial Rumors, Weishi Jia, Emory University; Giulia Redigolo, University of Padua; Susan Shu, Carroll School of Management Boston College; Jingran Zhao, Hong Kong Polytechnic University

 

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