Behavioral finance FAQ / Glossary (Consensus)

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Dates of related message(s) in the
Behavioral-Finance group (*):
Year/month, d: developed / discussed,
i: incidental

(market) Consensus


See sentiment, contrarian,
conformity,
projection bias,
bandwagon

Dissenters are welcome...
...as long as they agree with all of us.

Definition:

A consensus is a social phenomenon in which everybody (or nearly
everybody) in a group or population (*) agrees about something.

(*) The bulk of stock investors for example

To be more precise, it is an unanimity or quasi unanimity of opinion, belief
or knowledge on a topic, a prevision or projected decision, with an impact
on their common behaviors.

It has its positive aspects but also its dangers.

OK, looks like peace and love,
but better see what is behind it!

Forms...

Shaking hands or telepathy?

There is a difference between a formal or informal consensus:

A formal one is a common agreement that comes from a
   group discussion,

An informal one means that a large majority of individuals
   share
rather similar opinions on a specific issue

...and quality / effects

Rich or poor agreement?

The form of the consensus can have a consequence on its nature and quality.

A sound consensus would suppose, before being reached, a

well informed and contradictory analysis.

This is why not to leave key decisions to only one person, a rule
found in many institutions, limits the role of individual superficial
"intuitions" in favor of deeper questioning and analysis

But in practice it is not always what happens.

Harmful effects are likely when the consensus is
"too easy"
and rests on:

Reductive, narrow, superficial (lowest common

denominator) knowledge, belief or feeling,

Or pure mimicry and peer pressure, sometimes because
    of laziness, sometimes because of habit, reflex or mental
    conditionning, sometimes because of ...cowardice

Or blind common emotion

Or collective delusion or

prejudice (stereotype).

Or an escalation of more and more radical opinions/
    behaviors
,
as every member tries to show its zeal.

Whatever is behind, a consensus is to be sought in various cases but
     is not a guarantee of reliability.

      Only its results, once known, will tell if it was right or wrong

Anyway, as concerns the relevancy of the assumptions on which it is based,
it can sometimes create a self-fulfilling or self-defeating prophecy,
depending on how it orientates behaviors.


Can one million people be wrong ? Of course, they can!

Informal consensuses in economics and finance

Converging market opinions. Shall we clap?

An informal or tacit consensus can take place:

Among investors and analysts,

for example on asset price evolution predictions.

Among economists, for example on economic growth predictions.

A yearly ritual!


Among businesses deciders in the same industry.
    They might for example:

Offer more or less similar goods and services,

Therefore none of them proposes specific advantages
and they neglect some potential markets,

Or start and stop simultaneous production investment, which

creates an alternation of glut and scarcity.

Well, consensuses in such matters might also be formal in some cases.
Another thing is that they might even take the form of collusion or
manipulation
.

Let us not elaborate: there is another glossary article about deception.

Types, origins and reliability of consensuses

Decisive or illusory consensus?

Type and origin

Reliability

Explanation

1a) An
equilibrium
found in
a rich exchange
of information and diverse,
even opposite opinions.

A thorough exploration
(pros and cons) brings a
broader picture of facts
and issues.

It might
seem a loss
of time, but
has a good
chance to
be reliable





Diverse opinions enrich
the debate and explore
better the issue.

They avoid to neglect
some aspects or info,
before the group members
reach a common
evaluation, solution or
decision.



1b) A
knowledge
consensus
among
"experts" on a topic
or issue that implies
a specific knowledge.


 

 



It has
some
chances to
be reliable.

 

 








Most of those who take a
stance know the topic.
Even so, checking is
useful
, errors can persist
in their collective mind
(social anchoring, routine;
paradigm, peer pressure,
urban legends...).

Expert crowds are slow to
admit new ideas / realities.
They can be self-centered,
overconfident, victims of
peer pressure, a bit blind
to the outside world.

2a) A conformity
of opinions reached without
exploring dissent possibilities.

Here, common cognitive or
emotional biases contaminate
the group members.


Then the
consensus
quality is
dubious.

 



It shows herding / peer
pressure / groupthink
with poor analysis and
lack of inside group
opposition..

This gives a premium to
blind obedience, routine,
laziness or emotions.

2b) A formal or informal

collusion, with
vested interests at
stake.



Here,
there
is a
smell of
possible
deception.



Whatever "good intentions"
or pretences (to protect
an industry, avoid market
panic, keep the system
running) as was the case
for subprime-related
securities / derivatives....

Are groups wise or psychotic?

As everything can happen, better be a bit paranoid about groups.

* It seems fine when their members make a common decision,
   instead 
of falling
into division and inaction.

* But it might be useful to dig deeper in what are the real motives
  
of such decisions, under this love for each others ;-)

On the other hand, collective wisdom (sometimes called the "wisdom
of crowds", as a counterweight to the "madness of crowds") exists,
and not all consensuses are dubious.

Also, when decisions have to be taken in an emergency, a too long
debate on existential doubts
might make miss the plane.

Do consensuses take time to be built?  

Knee-jerk group reflex or gradual evolution?


Sometimes a consensus is reached immediately, as a collective "gut feeling",
with few prior analysis.

But often, it evolves gradually, from:

Either a deep analysis that helps a rational opinion to

emerge (as in #1a seen above, or in some degree in #1b),

Or (case #2a seen above) a social dynamical process,

tainted with emotions, which follows several steps:

1) At the start, except in case of strong emotional shock, the informal 

consensus is rather "wait and see", and only a few players dare take a
position.

Here we have underreaction, delaying tactics (committees
are slow to take decisions, to change their past orientations), or even a
status quo bias, when only a few people get convinced to follow a given
course of actions.

2) It is followed by an adjustment, in which more people get
     converted 
(by objective or subjective reasons),

3) And then by overreaction where either conviction or imitation
     spreads to most others (bandwagon effect).

Market consensus

Should we be wary when all market players, commentators,
analysts tell the same story?

Can that consensus reach saturation? And then deflate?
And what about surprises?

Market sentiment

In most cases, when the
market "sentiment"(see that word),
as the analysts or traders consensus, reaches
about 80 % of bullish or bearish opinions for
a market or for a stock, few investors liable to be
converted are left.

Then:

The trend starts to "lack fuel": it becomes hard to find new
   investors who feed it in the same direction.

The odds become high that conversions of beliefs and attitudes in 
   the other
direction might happen.

Let us say that at least some caution is needed when this near
unanimity appears.

Contrarians (see that word) go further usually, by taking it as a signal that
thetrend will revert.

Earnings predictions

When seers see ...after the event.


In financial markets, the "analyst consensus" on a company's next
quarterly results becomes the reference point for

"earnings surprises" (see surprise) on the day the real
results will get published.

The gap between the average prediction and the real figures will decide
f the stock price reacts with a zig or a zag.

   Two types of reactions are possible every time the published earnings

   deviate from the consensual prediction:

It is a signal on which market players will make fundamental
   value adjustment
(see adjustment) with consequences on
   market prices.

Paradoxically it is also the signal for analysts to adapt - a bit late -
their analyses, which often were unprofessionally combining
mimicry and underreaction.

It means that they let the market do their own analysis job
before
adjusting their own ones! They did not see the
train coming!

Or it is just a volatility blip, as a deviation in such a short period

is hardly fully predictive of the longer trend.

(*) To find those messages: reach that BF group and, once there,
      1) click "messages", 2) enter your query in "search archives".

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 This page last update: 21/07/15           

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