AXA Chairs
France
Chair in Financial Market Risk
Traditionally, the media, our main purveyor of information, was thought to have no effect on the markets, since the news it reported would arrive too late to influence many decisions. But information flows faster today, and Prof. Peress set out to test whether communications can take a more active role. He identified strikes in the newspaper industry of four different countries as a source of variation in media activity that is independent of stock market activity. This allowed him to see what impact the papers were having on movements in the market. During the strikes, trading volume fell and stock prices moved less than usual, showing the effect of missing information, usually propagated by the media. “If there is a strike on Wednesday, Tuesday’s news is not reported,” Prof. Peress explains. “It will eventually be incorporated into stock prices, but the market misses a beat.” Whatever perturbs the media, then, could be felt in the market, making it both an active player on the markets and a previously unrecognized source of financial risk.
Information is also active when it comes to innovation. Joël Peress has found that there is a positive feedback loop between the effort of entrepreneurs to innovate and the effort of potential financiers to understand their work. He explored this by studying the impact of pro-innovation laws on the number of financial analysts following the companies concerned. As innovation increased, the number went up, indicating financiers becoming more informed. Conversely, when certain brokerage houses closed, effectively removing analysts who were studying these companies, the level of innovation suffered, confirming the importance of information provided to financiers. The consequences for the economy are significant. Innovation is a major factor affecting growth and, thus, so is the allocation of its funding. The ability of financiers to evaluate innovation accurately, based on the information at their disposal, becomes key. “Each half will make the economy grow faster,” Professor Peress concludes, “but an economy with both will grow even faster.”
Information, Innovation, the Media and the Market
1st Rule of Finance Club: Information is Power
Since the onset of the global financial crisis of 2008, the financial markets are under increased public scrutiny. Indeed, there is no doubt that excessive risks have been taken prior to the crisis, but how did information, notably the mass media, play into financial actors’ decision making? News and “noise” have, and keep being diffused through the economy, but their diffusion is much faster than in the past thanks to advances in information technology such as the internet, electronic filings and social media. Investors, both institutional and individual, have now access to vast amounts of data, in real time and at low cost. Indeed, Information is crucial to the evaluation of risk, whether about an asset’s fundamentals [1] or about the asset’s allocation among investors. What is the impact of this deluge of information on financial markets? Does it improve financial decision-making? Or does it create more risks?
As public opinion of the financial markets and banking has swung to an almost nihilistic extreme, governments struggle to find incentives to help the financial sector evolve, and effective new regulation notably to address the following questions: how much and what type of information about financial intermediaries should be made public?
While these questions have already been addressed in the literature (among others by Professor Peress, the new AXA-INSEAD Chair holder, himself), they remain largely unresolved, notably due to the lack of extensive and novel data to bridge the gap between theories and empirical observations, and due to resilient controversies around the efficient market hypothesis. Consequently, now is the time to look constructively at those issues, with a view to helping prevent future crises and dissect financial markets’ systemic risks: Professor Joel Peress’ research within the scope of this new AXA Chair fits well with INSEAD’s efforts to further and strengthen its research in financial markets.
Despite being no behavioral economist [2], Prof Peress’ work challenges the notion that financial markets are “efficient”, ie. that the prices of assets and shares will always incorporate and reflect all available information about their underlying, fair value. Theoretically, this hypothesis makes it impossible for investors to either purchase undervalued stocks or sell stocks for inflated prices. Joel Peress’ belongs to a line of criticism which does not depart with the assumption of rationality but instead argues that markets are replete with frictions [3] that prevent rational investors from implementing the trades that would allow risk to be efficiently shared and information to find its way into prices.
Thus, Professor Peress chose to focus on understanding the factors that shape the information environment in financial markets, and its implications for the risks that agents bear. He analyses how information diffuses gradually across the economy through various channels, generating specific observable patterns, and is notably interested in the impact on risk of technological changes, such as the internet or computerized trading. The challenge of this particular brand of research is that information is by essence unobservable, so Professor Peress adopted an innovative approach to rational choice models to deliver testable predictions. By modeling information as the result of a decision process, he succeeded at establishing links from observable characteristics to observable outcomes, links that can then be put to the test. He has shown, for example, that the degree of competition in firms’ product markets or their coverage in the media is connected to their stocks’ trading volume or their cost of capital. Such links had not previously been uncovered, not because they were not important, but because of modeling or data limitations. Thus, Professor Peress has also displayed an impressive sense of entrepreneurship by collecting novel data.
Last but not least, Professor Peress emphasizes that the lack of information about financial intermediaries’ exposures generates risks, many of which are systemic because of the size of these intermediaries and their interconnections. This raises important questions about the organization and transparency of the financial sector.
As a former Associate Professor of Finance at INSEAD, Professor Peress’s innovative research has already earned international recognition, thereby contributing to the school’s long standing level of excellence in finance and business management around the world. Between 2009 and 2012, he was twice awarded the prestigious Smith Breeden Prize for the best paper published in The Journal of Finance (the top-rated outlet for finance academics), an honor that has been bestowed on very few European scholars, along with the ‘Best young researcher in Finance’ prize awarded by the Institut Louis- Bachelier and the Institut Europlace de Finance (France) in 2011.
INSEAD’s extensive international network, once used to leverage Joel Peress’ skills, will undoubtedly contribute to the establishment of a strong and thriving research programme in Financial Market Risk destined to carry out groundbreaking work in the broad range of finance disciplines.
[1] For a stock, for example, fundamentals include the firm’s expected future profitability, risk profile, management quality, pipeline of new projects etc…
[2] Economists who apply insights from psychology to finance and question financial agents’ rationality
[3] Frictions include asymmetric information, short-selling constraints, limited access to capital, market-entry costs, liquidity, incentives and agency issues etc.
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Joel
PERESS
Institution
Institut Européen d'Administration des Affaires
Country
France
Nationality
French