Retail investors are more likely to think there will be a catastrophic stock market crash if they have read media reports about recent market falls, new research in the US shows.
But institutional investors are less swayed by the press when working out the likelihood of a crash.
Individual investors are also more likely to think there could be a market crash if they have read media reports about a recent earthquake, even if they didn’t feel any tremors, the preliminary research showed.
On average, investors think there is a 19 per cent probability of a severe one-day market crash on the scale of 1987 or 1929 — that is, a fall greater than 12.8 per cent in a single trading session.
That assessment is skewed by a smaller number of “huge pessimists”, Yale University professor and study co-author William Goetzmann told a conference in New York last week. The median probability is closer to 10 per cent.
But even 10 per cent is far too high an estimate of the likelihood of a crash, given such events have been historically infrequent in the US, Professor Goetzmann says, suggesting the actual probability is closer to 1.5 per cent.
The research drew on regular surveys conducted by Nobel prize-winning economist Robert Shiller, which ask investors to estimate the likelihood of a severe stock market crash occurring over the next six months. The survey data extends back to 1989.
Professor Goetzmann identified a weak but significant link that the combination of recent negative market returns and a high proportion of negative news stories affect private investors’ assessments of crash probabilities.
Negative market news can keep affecting someone’s crash perceptions for up to four days after publication, the research found.
Weak magnitude earthquakes were also associated with increased estimation of crash probabilities. But the research found this was only true for individual investors, not for institutions.
The crash probability assessments can be important because they can determine stock market participation and the demand for insurance against crashes, Professor Goetzmann says.