Summary of A Tough Act to Follow

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Economists studying the machinations of markets have posited behavioral theories on how participants formulate their decisions. Rational expectations, adaptive expectations and the efficient market theory provide insights on the ebbs and flows of asset prices. But professors Samuel M. Hartzmark and Kelly Shue offer another vantage point on equity price fluctuations: “Contrast effects” occur when previous information creates a bias among investors. Traders, investors and analysts interested in exploring market behavior will find this a valuable report.

In this summary, you will learn

  • What “contrast effects” occur in financial markets,
  • Why these effects matter for market participants and
  • How investors should assess these behavioral biases.
 

About the Authors

Samuel M. Hartzmark is a professor at the University of Chicago Booth School of Business. Kelly Shue is a professor at the Yale School of Management.

 

Summary

When people evaluate the attractiveness of a romantic partner, a job candidate or a potential new home, they often make decisions by comparing the current option with previous ones. Such “contrast effects” can skew perceptions of choices higher or lower than their real value and lead to poor decisions. Researchers set out to determine whether contrast effects can also bias investors’ actions in financial markets. Investors and traders pay close attention to quarterly earnings reports to monitor the health of a firm and forecast its future stock price trajectory. Even before the earnings announcement, analysts predict the amount of earnings the company will report. In the event of a surprise, in which earnings turn out to be significantly higher or lower than expected, market participants propel the share price up or down accordingly.


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