Rumors in Financial Markets: Insights into Behavioral Finance

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Rumors in Financial Markets: Insights into Behavioral Finance (The Wiley Finance Series)

A rumor can be everywhere, at any time, at any place. It is perceived as something mysterious, almost magical. A rumor frequently produces a hypnotic effect. It fascinates, overwhelms, entraps and stirs up people’s minds. Rumors are the oldest mass medium in the world and their nature is still difficult to grasp. What is so special about rumors, that people get so excited, anxious and nervous? Why do companies release press bulletins stating, ‘We don’t comment on rumors’? People do not know too much about this important social phenomenon, especially from a scientific point of view.

Where does it start, how does it develop, where and when does it end? How does it differentiate itself from gossip, legends and just ordinary information? How are rumors spread, when are they believed and what kind of an impact can they have? Everyone believes they are able to recognize a rumor when they are faced with one, but no one can give you a satisfying definition of it.

The longer people think about rumors, the more they realize how difficult it is to set limits on what they are and what they are not. Why is it so difficult to capture the exact content and functionalities of a rumor? There are at least two possible explanations for that. The first explanation is that a rumor is not observable from the beginning to the end. When people start studying a rumor, it is usually already dead or in the final phase. In many cases it will be very difficult to find out its starting point and development process. The second possible explanation is that rumors, at least until a few years ago, have included a moral aspect. This prejudice has made people think more about the moral entitlement of a rumor than of actual functionalities.

1 One of the most central elements of the Theory of Finance is the economics of information and how new information is updated to reallocate scarce resources. Rumors are a special form of information and their special characteristics have to be accounted for when applied to the Theory of Finance. Since rumors involve not only financial but also psychological and sociological elements, it is necessary to apply an interdisciplinary approach when analyzing rumors in financial markets.

While the individual behavior when faced with rumors in financial markets is one aspect to be analyzed, probably the more interesting one is to search for behavioral mechanisms on an aggregate level. One of the goals of this work is to evaluate whether rumors lead to systematic behavioral patterns when trading assets in a financial market. Unfortunately, from a scientific view, not too much is known about rumors, in particular in financial markets.

This is somewhat astonishing, since rumors on the one hand have a very long history and are known to be a very efficient mass media communication channel, and on the other hand appear almost on a daily basis in technical newspapers and magazines.

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