COVID-19: Social networks helped spread fear among investors

image shows a graphic featuring social networks

By Elaine Smith

A York professor specializing in behavioural and social finance worked with two former PhD students to research the role that social networks played in emotional decision making among mutual fund managers in five hot spot cities in the United States.

Stuck in lockdown during the spring of 2020, York finance professor Ming Dong and two of his PhD students began to suffer from the lack of in-person social support and wondered if everyone else was also relying on Facebook to get together.

Dong, an associate professor of finance at the Schulich School of Business, specializes in behavioural and social finance, a cutting-edge area of finance research. He and his former PhD students, Shiu-Yik Au, now teaching at the University of Manitoba, and Joseph Zhou, now teaching at Ontario Tech University, realized that the COVID-19 outbreak, as devastating as it was to daily life, could be a natural experiment to explore social finance. They hypothesized that the behaviour of institutional investors (i.e., mutual fund managers) would be influenced by fears about COVID-19 which might lead them to sell stocks as the market dropped in response to the WHO announcement.

Ming Dong
Ming Dong

“In behavioural finance, we believe that emotions affect trading and investing decisions,” says Dong, “so we decided to look at mutual fund managers, who are professional investors, to see if their behaviour reflected pandemic fears. We discovered that even they are influenced by fear.”

The trio based their study in the U.S., in part because of the variation across states in response to the pandemic, and made three hypotheses: (1) fund managers in cities defined as hotspots based on the number of cases would be more affected by fear and divest themselves of more holdings than those in less-affected locales; (2) social media contact between hot spots and other locales would lead fund managers in those locales to divest themselves of more holdings than those in places where there was weak social media contact with hot spots; and (3) the most skilled managers should be less affected by panic.

Using case numbers, the researchers identified five hot spots in the U.S.: Chicago, Detroit, Los Angeles, New York City and Seattle. They then turned to Facebook data that showed social media connections between the hot spots and other cities to identify those cities with high social media traffic and those without. They measured fear among mutual fund managers in each of these cities by the volume of their buy and sell decisions in March 2020 after the WHO announcement and measured skill using past returns.

Dong and his students found that the data confirmed their hypotheses. In the hot spots, fund managers sold off more total stocks in March 2020 than did managers in the other cities across the country. In addition, they discovered something interesting: in the cities with strong social media ties to the hot spots – such as Miami, home to many NYC snowbirds – fund managers were even more fearful than their NYC hot spot counterparts and sold off more stocks, while those in cities with minimal social media connections to hot spots sold off fewer stocks than either the hot spot fund managers or those in connected cities. They also found that skilled managers were much steadier, avoiding fire sales and coming out of the initial crisis virtually unscathed.

In other words, notes Dong, “If colleagues or investors in NYC tell me on Facebook or Twitter about all the fear that is rampant there, as a Miami fund manager, I will be influenced and more likely to sell – even more likely than my colleague in NYC, the hot spot.

“Our study provides confirmation that emotion matters in trading,” Dong says. “Classical finance assumes investments are rational, but behavioural finance proves that the opposite is true, even for professional investors. They are also human beings and influenced by emotion.”

But, “if you’re skilled, you tend to make better decisions,” Dong says.

All of this information, he adds, should be useful to investors in choosing a fund manager; to fund managers as a reminder to make rational decisions based on a stock’s fundamental value; and to policy-makers as they attempt to steer the economy through a crisis.