A fundamental debate
Economists never stop debating the fundamental question whether stock prices are solely determined by rational considerations. Until the 1980s, it used to be widely assumed that stock prices are determined by purely rational processes. However, this assumption has come under increasing scrutiny, including from Robert Shiller, the recent Nobel Prize laureate. An increasing number of factors that would appear irrelevant from a rational perspective were found to play a role in stock price formation. A new field of research, now known as behavioural finance, was born..
The emotional investor
An important factor – that sits awkwardly within the rational framework yet does influence stock prices – are investors' fluctuating emotions. Stock prices turn out to be sensitive to a range of factors including variation in the amount of sunshine, the daylight saving time changeover and the outcomes of sporting events. Investors tend to be more bullish, for instance, when their favourite football team has done well. It is not uncommon for stock prices to fall on the day after the national side drops out of the FIFA World Cup competition.
Elimination depresses stock prices
Recent research shows that emotions influence stock prices even where a high degree of rationality in price setting might be expected. The study in question looks at the stock price of a company listed in multiple countries including France and Italy. In particular, it examines the way the stock price responded to the elimination of these two countries from the 2010 FIFA World Cup in South Africa. The stock prices in both countries are expected to remain quite close to each other, because any difference would create an opportunity for investors to make a quick profit.
However, even during a match, stock prices in the country whose team faces elimination fall significantly below those in the other country. On 22 June, for instance, France played its final group match against South Africa. At half time, the French faced a 2-0 gap to bridge, failing which they would be eliminated. The mood among investors in France soured, and stock prices fell. Figure 1 shows how clearly the price effect showed in the share under examination. At the close of the trading day, there was a strong downward movement in the price deviation between Paris and Milan, because the price in France dropped suddenly.
Figure 1: Price deviations during football matches