Identifying Reflexivity

Abstract: Abstract  Master thesis in Business Administration, School of Business and Economics Linnaeus University 4FE17E VT2022  Authors: Eric Månsson & Marcus Nykvist  Supervisor: Magnus Willesson  Examiner: Christopher von Koch  Title: Identifying Reflexivity  Keywords: Reflexivity, EMH, AMH, fundamental value, market value, feedback loop, cognitive function, manipulative function.  Background: Current economic theory describes the risks the financial markets face as exogenous in nature. Several studies suggest the presence of an unaccounted-for risk which is not exogenous in nature but endogenous. Seemingly, the initial risk is exogenous but through the interaction between the market and its participants this risk can be either amplified or dulled. As such, current economic theory illustrates only partially the risks of financial markets as they do not account for endogenous risk. A theory is necessary which not only acknowledges the influence of exogenous risk but also considers the impact of endogenous risk after the fact. The theory of reflexivity offers a solution to this problem as it considers the interactions between the market and its participants and how these two affect each other, through the so-called cognitive- and manipulative function.  Purpose: As reflexivity entails a more complete description of the behavior of financial markets than current economic theory, the purpose of this study is to identify its occurrence.  Method: This study uses a deductive research approach along with a quantitative strategy to test its purpose. The utilized model is constructed through the theory of reflexivity and the implications this theory poses toward statistical testing. The study conducts its testing on a random sample of firms from the S&P 500 between 1992-2021 using annual data.  Results: The results of the study are invalidated due to the use of weak instruments in the market model, and due to a lack of endogeneity in the fundamental model. As such, the occurrence of reflexivity cannot be confirmed through this study. An interesting ancillary finding however is a methodological implication which suggests that different proxies for fundamental value as well as different instrumental variables may be necessary given a certain context to identify endogeneity and instrumental relevance respectively.