by Arshid Hussain Peer and Md. Qamar Azam 1 February 2023
The story so far: on 24th of January Hindenburg Research, the forensic financial research firm published a report on the Adani group. The report accuses the Adani group of accounting fraud and manipulation. Since the publication of report, the fortune of Adani groups chairman has declined by 1/5th pushing him to the 7th spot in the elite list of world’s richest billionaires. As of 27th January, the group has lost the total of 51billion USD in market capitalization. This is the biggest fall in the group since 2017. The stock market during the intraday trading sessions also tanked. The Standard and Poor (S&P) Bombay Stock Exchange (BSE) Sensex crashed over 1,100 points to 59,065. The National Stock Exchange (NSE) Nifty also fell over 2 per cent to 17,522 as volatility spiked sharply during the intraday trading session. The Adani group rejected the claim by describing it as “intentional and reckless attempt by a foreign entity to mislead the investor community and the general public”. And at the same time have hinted of legal action against the Hindenburg Research. These developments are not only worrying for the Adani group or investors, but has implications for other sectors of the economy. In this short piece our aim is to explain and rationale and implication of such investor behavior to the news. In doing so we will take the cue from Behavioral economics.
It was Israeli psychologist-Amos Tversky and Daniel Kahneman- whose work on uncertainty and risk during 1970s and ’80s identified many biases which hamper the people from making rational decisions. The behavioral economics makes use of elements from Psychology and economics to understand how and why of human behavior. The behavioral economics considers that human decision is subject to emotions and impulsivity which in turn are influenced by ecological factors. As a result of which the decision taken by human are not perfectly rational but their rationality is bounded. This bounded rationality results in many biases in decision making and decisions are taken without fully processing the whole information. Broadly the human decisions suffer from availability heuristic, prospect effect, overconfidence bias and herding.
The investors in the stock market mostly invest in the stock without understanding the fundamentals of the company. The reason for so is that in the real world, there is information asymmetry and obtaining information is costly. The costs are in the manner of devoting time to do some basic research on the stock, developing the mental capacity to understand the same or hiring third party to do. Most of the investors take the short route by free riding on the decisions of other people which is called the thumb rule in the market. As a result of which like the sheep’s follow the direction of first sheep, the investors also display the herding mentality. This herding results in the appreciation or depreciation of the stock. The same was at display in the case of Adani group. With the publication of the report and the subsequent reporting on the same by various media outlets resulted in the sell off the Adani shares. Had the investors been rational they would not have invested in this conglomerate. Here the investors suffer from herding bias where the people underestimate their own knowledge and follow the market blindly.
Now coming to the next part, that is what led to its decline and what is the economic logic behind the same. To understand this, another concept of behavioral economics- overconfidence bias- comes to our rescue. In this type of bias investors put the preference for their own knowledge above the actual behavior of the market. Most of the investors invested in the group by seeing the groups dominance everywhere. Add to this the social media penetration, they consider the Adani group too big to fail. This results in overconfidence bias in the market. There was the steep rise in the stock prices of Adani group companies. To understand the overconfidence bias more clearly, consider this. The stock prices of Adani group companies on average have appreciated by around 819 % during last three years, as per the estimations of the Hindenburg research.
It is to be noted that there might be some investors who are still overconfident. These overconfident investors will wait and watch the market on basis of their estimation and knowledge. They might be thinking that the report published by the agency is to malign the company image. So, they will follow the market closely and will take decisions. There is also chance of buying more of Adani stocks in notion of increasing its value in the future. Similarly,
the risks averse investor will follow the market sentiment to prevent further losses and will sell the stock at given price to avoid losses known as loss aversion. The category of investors includes individual investors, new entrants in the market who have less knowledge to the market and their decisions are primarily based on market movement. But at the moment, the market dynamics and stock performance of same group is showing herding bias is dominating over overconfidence bias.
There is also availability heuristic which bias the people’s judgement. The availability heuristic is a phenomenon where people on evaluating the likelihood of the particular event relay on easy recalled information rather than data. In the current scenario, the behaviour of investors to invest in the group can also be explained by the availability heuristic effect. The positive news about the company in the media and its founders resulted in monumental growth in their stock prices.
In all these circumstances, it is the information which plays the vital role. It can be both good and bad depending on how investors perceive it. If it is good news investors will be optimistic in the market and trade aggressively. The bad news is not always harmful but sometimes it acts as a blessing in disguise as it has been seen during COVID-19. There has been large influx of new investors into the market on the pretend of earning profit in different stocks.
Conclusion
The investors are not only governed by the market regulators but it is their psychological behaviour, sentiment, mood which play crucial role in their investment decisions which contradicts the modern theory of finance that is Fama “Efficient market hypothesis” which says all the information are publicly available for the investors. It can be said that information asymmetry will always be in the market and need to be reduced to avoid panic and risk of the investors. Though Securities and exchange bureau of India (SEBI) guidelines like Additional surveillance mechanism among others is step in right direction. But there is a need to aggressively push for investor education with special focus on behavioural finance and elementary mathematics. This will not only go in a long way enhancing the human capital of population but also help in preventing the financial crisis type situation.
The authors are Research Scholars at the Department of Economics, Jamia Millia Islamia New Delhi.