Chapter 94 Question 084

Why do stock analysts seldom recommend which company's stock to sell? To provide a plausible explanation for this bias, let us look at the costs and benefits faced by stock analysts in making recommendations.Imagine five different analysts covering the same stock.Everyone wants to make an accurate prediction of where the stock's price will go next month, but they also want to maintain a good relationship with the company being evaluated (mostly a client or potential client of their boss). With the above in mind, analysts would very much like to consult the possible recommendations of the other four analysts before taking a position on their own.After all, he knows the cost of being wrong depends in part on the recommendations made by four other analysts.From the outset, he understood that other people's recommendations were likely to be slightly biased towards buying, because it was beneficial for the analyst's employer to flatter the company under review.Taking a step back, if five people all recommend buying and the company's stock price falls, that would be a common misforesight for the analyst, and he would have limited personal criticism.

Conversely, if he recommends selling and four others recommend buying and the company's stock price goes up, he's a triple loser.Not only was he wrong in his recommendation, but the error was noticeable because competitive analysts saw it right.To add insult to injury, his employer would be hated by potential clients. In this case, the safest thing for an individual analyst to do is to make the same recommendations as other analysts.Everyone understands that it is in the interests of their bosses and the bosses of other analysts to make buy recommendations.In addition, other analysts not only analyze the performance of the company's stock, but also analyze what kind of recommendations others will make. Therefore, it is easy for us to understand why the safest way for analysts is to give buy recommendations.Of course, the savvy investor will eventually know what a stock's future price was at the time of the buy recommendation, providing little useful information.

The fact that market transactions always occur between several parties with potentially conflicting interests is not so much the exception as the rule.The seller wants the buyer to say how much he is willing to pay, but the buyer is afraid that the seller will charge too much, so he tries to hide his true intentions.Likewise, the buyer wants to know whether the product he is considering is good enough, but the seller, who knows the truth, is unlikely to disclose the product's defects.In such a situation, how can decision-makers obtain more relevant information? Biologists have long used basic economic principles to try to answer such questions among animals with conflicting interests.Let's say two dogs both want to gnaw at the same bone, and each dog is eager to learn about the strength of the opponent before deciding whether to fight.It is impossible for the opponent to publicly announce how strong he is, because I am very strong!You better not grab this bone from me!Words like this are not credible.

In such a situation, the dog can only implicitly rely on the principle of difficulty to falsify, that is, if a signal between potential adversaries is true and reliable, it must be difficult (or too expensive to falsify) to falsify.Size is one such signal, because the bigger the dog, the more likely it is to be a tough fighter.If a dog encounters a significantly larger opponent, it is likely to back off.But if the opponent is obviously smaller, then it is willing to fight. In this case, the dog will try to appear larger.Once they arouse the emotion of fighting, the smooth muscles around the hair follicles on the back immediately tense, causing the neck hair to stand up and appear larger.But by natural selection, all living dogs have this bodily function, so no one will be fooled by it in the end.Whether the ruff is erect or not, a dog that looks bigger is actually bigger.

Why are the chicks who scream loudly in the nest most likely to be eaten by the worms brought by their parents?The hard-to-counterfeit principle is also explained.Each chick wants as much food as possible, so it cries loudly to show how hungry it is.But since its siblings have adopted the same strategy, the signal doesn't seem informative.However, experiments have shown that hungrier chicks sing louder.Motivation matters here, and the necessary motivation for the highest pitch is that the bird is really hungry. The impediment to counterfeiting principle also applies to communications between potential counterparties under different market conditions.