How stock market inefficiencies can affect the real economy

How stock market inefficiencies can affect the real economy

How a dynamic flow-based investment strategy outperforms a market portfolio. Credit: The author

Mutual fund investors are known to be vulnerable to changing market conditions. What is less well understood is how corporate managers are affected by waves of investor optimism. A researcher published a study in the journal Financial innovation, where he argues that corporate managers and investors are jointly gripped by market euphoria. Using a long time series of aggregate flows in and out of bond and mutual funds as a substitute for investor sentiment, the study’s author, Thorsten Lehnert, a professor in finance at the University of Luxembourg, shows that the joint “mood” of managers and investors can to predict the effectiveness of an investment strategy that relies on differences in the investment behavior of corporate managers.

Prof. Lehnert focuses on the so-called investment factor, an investment strategies which is long in a conservative investment portfolio and short in an aggressive investment portfolio. He explains that “stock prices of companies with high and low investments are differently affected by euphoria at the market level. For example, the observed incorrect pricing during periods of euphoria and subsequent adjustment is particularly pronounced for a high investment portfolio compared to a low investment portfolio. As a result, the effectiveness of the investment factor can be predicted with the help of information on retail investors“optimism and pessimism”.

Interestingly, the relationship between past flows and the investment factor is not only statistically significant but also economically significant. The study shows that, in general, an integrated trading strategy consistently and significantly outperforms static strategies and generates significant annual alpha of 7% after taking into account well-known risk factors. Interestingly, the flow measure, which serves as a substitute for market euphoria, dominates other well-known indicators of investor sentiment.

“So far, it is widely believed that retail investors are” inclined “and behaving irrationally. My explanation that corporate managers and investors are jointly gripped by market euphoria offers a new perspective on how financial markets it can affect the real economy, “explains Prof. Lenert.” It seems that the inefficiency of the stock market is important even for the real decisions of companies, “he concluded.


Price noise proves the key to highly effective beta betting investment strategies.


More info:
Torsten Lehnert, Corporate Managers, Price Noise and Investment Factor, Financial innovation (2022). DOI: 10.1186 / s40854-022-00365-2

Quote: How stock market inefficiencies can affect the real economy (2022, June 17), retrieved on June 17, 2022 from https://phys.org/news/2022-06-stock-inefficiencies-affect-real -economy.html

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