The problem with public information
Are investors “mad” to follow CNBC’s Mad Money host Jim Cramer’s stock advice? Would they be better off without media’s insights? New research suggests they would.
“People put an enormous amount of weight on information delivered via the media,” says Haas Prof. John Morgan. “As a result, investors become less likely to use the information in an optimal fashion to price the stock. The cost of our markets functioning based on mispriced stocks is greater than the benefits of having public information.”
In the working paper “Experiments on the Social Value of Public Information,” Morgan and co-author Donald J. Dale of Muhlenberg College suggest that policymakers must balance the costs of transparency with the effects of distorted information.
“The ‘echo chamber’ effect of public information can ruin the way the market should function,” says Morgan.
For this study, undergraduates participating in a stock trading game were given two types of private information: high quality/reliable and low quality/less reliable, correlating with fundamental information (a stock’s intrinsic or true value, not market value). Later, they were given public information. Participants tended to overweight the low-quality information in all rounds of the experiment.
“It places investors on the horns of a dilemma,” says Morgan. “We would all be better off cooperating but our individual interests are strong. If everyone else is following the news story, then most people think the best thing they can do for their investment strategy is to follow along even if they know they may be wrong.” —PT