11.3.1 Google and volatility

So far we have seen that the degree of volatility asymmetry is linked to two characteristics of the financial market in question: the share of private investors and the number of stock analysts. The aim of this section is to illustrate in a more detailed way how private investors can impact the stock market and discuss a convenient metric of their behavior. This exercise might be helpful to portfolio managers, who are often concerned about the “little man's” actions, which are argued to be more susceptible to swings of mood, especially in periods of market stress.

There are reasons to believe, frequently based on insights from behavioral finance, that private investor demand is more attention-driven than a systematic investment approach should be. Private investors tend to follow simple heuristics, like picking stocks they have positive associations with or the ones recommended by friends or neighbors. This does not necessarily imply (as some would be happy to believe) that they will inevitably be driven out of the market. In a rather provocative experiment Gigerenzer (2007) showed that asking random people on the street for names of stocks that they know and subsequently investing in them can be a very successful strategy. But even if simple investment strategies fail in the long run, the next generation of inexperienced investors will readily replace their frustrated predecessors. The reliance on simple heuristics ...

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