Risk Choice Behaviour

Financial Analysts are often perceived as experts who incorporated information regarding their field, i.e., finance and investments immediately as they make predictions on future earnings (forecast), and give advices on stock markets based on their rational analysis in an unbiased way.

Nevertheless, like normal human-beings, the decision-making process of an financial analyst is also affected by various factor as several studies have reported inefficiencies and/or biases in analysts’ ability to incorporate new information into their earnings forecasts, albeit the results of these studies have been mixed.

Specifically, when the accuracy of initial earnings forecasts is evaluated as a loss (a loss is deemed to have occurred when the estimation on earning made by the analyst is not met by the actual earning), analysts will choose more risky prospects when issuing revised forecasts. As a result, risky choice may lead to optimistic forecast behaviour. Furthermore, the prospect of getting incentives also deter the analyst to display a more risk tolerant character when making revised forecasts, regardless of the accuracy of their initial prediction.

This finding has proven that financial analyst, no matter how qualified or experienced they may be, tends to make biased predictions, estimations and outlooks as their thinking circuit is affected by the incentives and various motivational factors as well. Therefore this has somehow explain why the experts in Wall Street have been giving comments such as prices for petrol would not reach $100 per barrel 2 years ago, only to get shocked by the price that peaked at $147 last July, and this time, Wall Street experts also claimed that the subprime crisis and housing bubble would not have the effect we are not experiencing that has cast a huge gloomy shadow on a global scale. Need more proof to convince that experts might not give rational prediction?

Look at the technological bubble, before the bubble burst, and even the bubble had burst, so called experts still claimed that the growth in world wide web and technology would not be saturated, forgetting to take into account limiting factors.

The ups and downs in the market should be predicted by those experts if their expertise and knowledge were really to be such rational and accurate. But there are other factors at work here, like the incentive they would receive, and their bullish egoism. Analysts tend to be more motivated to take riskier action after suffered an initial loss, prompting them to make more mistake by being more risk tolerant. Analyst who would gain more incentive or lucrative deal would also tend to take more risk, after all, higher risk comes higher return.

Hence, people, the public should be aware that no one can help us to make any single decision, no matter how light the decision may be, or how handicapped we are, we should always make the recommendations, predictions made by experts as our guidelines and reference point only, but not to follow what they say, because, their decision may biased toward their own perspective, but not ours.