Journalists occasionally describe a stock price movement as a "buy on the rumor and sell on the news" (BRSN) pattern. Although this expression is relatively common, there is little awareness of its origins or implications. BRSN describes a real and predictable pattern of security price movements in the financial markets. The markets were generally theorized to be purely efficient, with prices set rationally, until research in the last 30 years began to demonstrate otherwise. Words such as quasi-rational, boundedly rational, and non-rational are now used to describe financial markets in academic discourse. Quasi-rational markets are random the majority of the time, without arbitrageable patterns. At times, however, quasi-rational markets do show repeating and predictable patterns such as B RSN.
There is a conceptual problem with declaring the existence of patterns in the financial markets. If a security price pattern exists and can be predicted, arbitrageurs should exploit that opportunity until it is
"arbitraged into oblivion." BRSN is a pattern typically identified in hindsight. It arises out of human psychology, often in unexpected places.
Because it arises out of human psychology and evades exact mathematical codification, BRSN makes occasional but enduring appearances in contexts both within and beyond the financial markets.
The foundations of BRSN lie in the way humans perceive and process risk, generate emotional reactions, and collectively behave in market environments. Risk perceptions are related to an individual's past
experiences, accumulated information, and emotional reactions. Risk perceptions are often strikingly individual and context dependent. As a species we do have several basic brain functions in common, and individual differences and similarities in risk perception and processing can sometimes be traced to the structure and function of the brain.
Among financial market participants, risk perceptions are constantly in flux as new information arrives. Yet risk-related information occasionally provokes similar reactions among a majority of market participants. Market price reactions to new information are typically the result of surprising or unexpected news. At these times, the new information is quickly factored into prices. For the BRSN pattern to represent price inefficiency, news about the positive future event must have a delayed impact on investing behavior. Occasionally, market participants are gradually more attentive to, and gradually more excited by, a positive opportunity. This escalation of excited attention leads to a decrease in perceived risk and a concomitant increase in risk-taking behavior over time, as demonstrated in this chapter.
In general, the anticipation of a forthcoming reward generates a positive affect state. Affect is an emotional experience reflected in one's attitudes, preferences, feelings, and/or moods. Positive affect motivates both increased risk taking and increased purchasing behaviors. As the anticipated potential reward approaches in time, investors' positive affect is increasingly aroused. Following the delivery of an expected reward,
investors' affect regresses to neutral. This post-event net decrease in positive affect leads to more risk-averse protective investing behaviors such as sel.Iing (consummate with the new, less positive, affect state).
Investors often gamble both on an event outcome and on the anticipated price appreciation as a result of that positive outcome. Many naive investors are not aware that a positive event outcome does not necessarily cause security price appreciation. Naive investors may be surprised by their high levels of risk exposure when the elated affect that guided the accumulation of their high-risk positions dissipates following the anticipated event. Their diminished elation motivates increased caution (risk aversion) and investment repositioning (selling) of high- risk positions. In thismarket environment, a general increase in selling causes negative price pressure. Price decline alone augments investors' negative affect and increases risk aversion.
In order for the BRSN pattern to arise in a particular security or market, several environmental conditions must be in place. For a positive "rumor" to spread, it is essential that there be a positively anticipated event pending. The event's expected positive outcome provides the incentive to "buy." The positively anticipated event may or may not become known to all market participants simultaneously. If it is known to all participants instantaneously, the opportunity presented by the event must only gradually excite the wider audience. A lack of specific information about event details, overall positive market
sentiment (bullishness), no apparent downside risks from the event, relative event novelty, and a general lack of experience with such events among market participants all serve to enhance the BRSN price effect.
The BRSN pattern typically occurs over short time periods (days to weeks). Variations of the BRSN pattern appear both in the financial markets and in political and social contexts. These nonmarket B RSN patterns typically take place over years, as is illustrated in the closing discussion. In the financial markets, the B RSN patterns appears internationally in security prices of all types (bonds, stocks, commodities, futures, and options) when the appropriate predisposing conditions are in place. Examples of BRSN occur as market participants anticipate positive results from such events as national elections, central bank policy announcements, FDA approvals, earnings reports, and corporate product releases.
This chapter briefly describes the social, psychological, affective, neural, and behavioral processes that lead to the BRSN pattern in the financial markets. We first demonstrate a correlation between investor psychology and security pricing around anticipated events with several striking BRSN examples. Taking a multidisciplinary approach, we pull together research in the mathematics, finance, psychology, and neuroscience literature to support the correlation. Mathematicians provide evidence of inefficiencies in market prices.
Event studies in the finance literature demonstrate anomalous security (stock, commodity, bond, or option) price movements around the dates of anticipated events. From the psychology literature we extract evidence for the central role of cognitive and affective biases in altering risk perceptions and motivating decision making, often collectively.
Self-regulation theory describes the mental mechanism of goal anticipation and disappointment as the B RSN pattern progresses.
Neuroscience literature demonstrates the differentiation of the neural processes of reward anticipation, reward receipt, and loss. The arousal of affect (feelings, emotions, moods, attitudes, and preferences) can be traced back to neural events. In the conclusion, the implications of the BRSN pattern to larger social, political, and economic trends are discussed