Meta-Communication and Market Dynamics. Reflexive Interactions of Financial Markets and the Mass Media

Abstract:     
A widely held belief in financial economics suggests that stock prices always adequately reflect all available information. Price movements away from fundamentals are assumed to occur only infrequently, if at all. "False" prices are supposed to be corrected by the counter-actions of "rational" investors reestablishing equilibrium. However, empirical evidence of widespread irrationality among investors as well as theoretical insights into the properties of complex systems suggest that this view is too static. In fact, it can be shown that under certain conditions dynamic disequilibria have a considerable probability of being "locked in". The mass media play no mean role in this: By conditioning trend-following behavior and fostering coordination among large numbers of investors, the media can help bring about such destabilizing moves. Media attention can induce positive feedback by increasing the level of excess noise in the market while decreasing the number of perceived behavioral options. Meta-communication thus generated is a prime source of instability in financial markets.

Number of Pages in PDF File: 36

JEL Classification: C70, C71, G00, G10, G12, G14, N20

working papers series