By Laurent Germain et Anne Vanhems

We took a close look at the personality of traders to try and understand better how speculative bubbles work and we noticed that some traders do not act rationally. However they are not the only ones who affect financial markets.

For each transaction, traders have to take into account many parameters: market trends, competitors’ strategies and the latest news. But sometimes the situation gets out of hand, and other less rational aspects influence their decisions.

Studying why people make decisions can explain certain events

In spite of their experience, individuals sometimes act in a biased way. We may thus observe disproportionate reactions, such as buying shares at a price that is much too high in relation to their intrinsic value. These are illogical decisions which trigger speculative bubbles and stock markets then crash when everyone wants to sell assets simultaneously and their value collapses.

While it is now acknowledged that some traders do not act rationally at a given time, we still find it difficult to imagine that this might also be true for market-makers. These market-makers are organizations (mostly investment banks), or people, who set the buy and sell prices of assets: they are said to ‘quote’ the buying and selling prices and thus set the value of the assets. However, it is possible to demonstrate that some of these market-makers also make the wrong decisions. The market-makers are considered to be more experienced and “battle-hardened”. They are paid to stay one step ahead and traders are trained to analyze their latest strategies. As they are key players, it was difficult to admit that these market-makers might act irrationally, by increasing prices until red lights started flashing, or, inversely, lowering the price of shares in a context of increasing demand.

In order to study the effect of this phenomenon, we separated the two main biases. The first bias, related to the degree of optimism, causes the broker to misread the market trend. Thus when clues are showing that a share is about to lose value, he may think that it will soon go up again. The second bias, related to the level of self-confidence, leads him to over-estimate his own skill. He may then cause the price of the share to vary a lot, thus making the market more volatile. Now, the higher the volatility, the bigger the gains and losses.

The effects of these biases on markets

We first observed that the biases of market-makers affect the depth and liquidity of the market. A deep market is one in which the price remains relatively stable A liquid market is a market in which prices are not set aggressively (there is then a lot of buying and re-selling).

For instance, an optimistic market maker may think that the information he received is more reliable than it actually is and consider that his judgment is less crucial for his decision. He will then tend to overestimate the price of the asset, and traders (who buy and re-sell) will decrease the number of their transactions. When this market maker is too confident of his assessment, he will quote the share less aggressively and thus increase the liquidity of the market.

The tulip bulb crisis was the first speculative bubble and remains an outstanding example of a frenzied financial market. In 1636-1637, some bulbs were sold at more than 15 times the annual salary of the horticulturist and the volumes exchanged on the markets were completely unrelated to the actual number of available bulbs.

The first conclusion we can draw from this study is that market-makers who are too confident or not confident enough can make either profits or losses. When the market maker is pessimistic, but still trusts his own judgment, then price variations are seen to be weaker.

Prices increase mechanically, and the volume exchanged by rational traders is then low. Nevertheless, one conclusion of the study is that market-makers are able to take advantage of this market: the rise in prices does not affect the overall demand.

The results of this research also show that while traders with biased behavior trigger situations of disequilibrium, market-makers who are over-confident increase the likelihood that this will happen. For instance, an optimistic market maker amplifies excessive trading, which means that there are too many transactions. We can compare this to the Internet bubble, when both traders and market-makers thought they were witnessing the birth of a new economy and hence the likelihood of extreme growth.

The prices of shares in technology start-ups then went sky-high, uncorrelated with the actual profits of the companies and nevertheless, the number of transactions continued to increase. The March 2000 crash led to a recession in the sector but also in the economy in general with losses exceeding the profits made.

Moreover, we proved that there was an unexpected result: the fact that market-makers may behave in a biased way sometimes favors traders who are not very confident. In this case, a trader who lacks confidence may get better results than a trader who acts correctly. Consider for example a share whose value will not change. The optimistic market maker believes that it will increase and therefore sets a high price. A pessimistic trader believes that it will drop and therefore sells his shares, whereas a ‘standard’ trader will wait. In this case the pessimistic trader will make profits but not the ‘standard’ trader.

We may conclude from our research that the volatility observed may not only be due to traders, but may also be amplified by the attitude of market-makers. In fact, the last conclusion of the study is that in the extreme cases of levels of confidence, we observe excessive volatility and an excessive number of transactions. In a situation in which some traders lack confidence, market-makers who also lack confidence will cause rational traders to make too many transactions.

We are now working on a new more complex model which assumes that some market-makers act according to the way others do: in other words they no longer act as independent ‘black boxes’ but take into account the strategies of their counterparts.

Reference: This article written by Laurent Germain and Anne Vanhems and the article entitled “Irrational Market-makers”, co-authored by Fabrice Rousseau and Anne Vanhems, were published in Finance vol. 35, no. 1, April 2014. This article won the Prize of the French Finance Association 2014.

Practical applications

These unpublished results pave the way for new strategies in which traders and market-makers should consider that, both among their peers and their competitors, some agents may take biased decisions.

Banks expressed a lot of interest in the study when the article was published and we may assume that this theory has been integrated into their trading practices

Methodology

Our team of researchers constructed a mathematical model simulating the effects of psychological biases on markets. We defined two reference scenarios: the first in which all actors are rational and a second including rational and irrational traders dealing with rational market-makers. This enabled us first to illustrate the impact of trader irrationality. We then compared these results to a simulation in which all of the market-makers are irrational.

By Gregory Voss

How likely is it that the reforms launched in 2012 by the European Union (EU), with the aim of ensuring a high level of personal data protection for the citizens of its 28 member states, will become applicable in 2017? It is possible, but the European Parliament, the Council of Ministers and the European Commission have yet to reach an agreement: informal three-way discussions are taking place.

Since June 2015, these three EU institutions have been jointly drafting a text for the General Data Protection Regulation (GDPR). There are still a few points on which the parliament and the council disagree, in particular with regard to obtaining an individual’s consent for the processing of personal data, the rights and responsibilities of those collecting data, and the amounts of fines for non-compliance.

A commission proposal for new legislation on personal data protection was made back in 2012. But the draft regulation, passed by the parliament on March 12, 2014, is now awaiting validation by the Council. These reforms will help protect European citizens and their personal data even with respect to international companies whose headquarters are outside the EU, but who nevertheless process data online. While the degree of personal data protection in Europe is generally quite high, the financial penalties are too low, in contrast to those enforced in the United States.

When the three EU bodies have agreed on the final draft text, it can then be adopted only after two consecutive readings of the same text by the parliament, whose members are directly elected by EU citizens and after approval by the council, which represents the governments of the 28 member states. Once adopted (most likely in 2016, though some were pushing for adoption at the end of 2015), the regulation will become applicable in the two years that follow.

This GDPR will harmonize European law and may deliver an additional benefit by triggering a broader process that leads to the standardization of international legislation on protection of personal data. Moreover, the reduction of the administrative burden arising from this single piece of legislation will enable savings of €2.3 billion per year, according to the Commission’s calculations.

The process may seem to be taking a long time, but it has to be borne in mind that it took five years to finalize the 1995 European directive on personal data protection. The GDPR is essentially at the three and a half-year mark, so there is still time for this.

The GDPR has been subject to intense lobbying efforts by the representatives of those who process data. While they may slow down the legislative process, these actors can play a legitimate role in informing legislators about the practical realities faced by the companies who collect data.

Following the Snowden revelations, efforts to reform the legislation have experienced numerous upheavals. In June 2013, Edward Snowden, a former CIA consultant and a member of the National Security Agency (NSA), revealed that the US government had collected personal data concerning individuals living outside the US from nine of the biggest American technology companies, particularly as part of an electronic monitoring program known as PRISM. On October 21, 2013, the European Parliament proposed a text in which it was stipulated that the company responsible for data processing, or its subcontractor, would have to inform the data subject about any communication of their personal data to the public authorities in the previous twelve months. This provision is clearly influenced by the PRISM case.

In general, revelations such as this one, relating to data protection, help stimulate the debate about privacy in Europe, even if they have weakened trust between the EU and the United States. On October 6, 2015, as a result of the transfer of data on an Austrian citizen to the United States, by the European subsidiary of Facebook, the Court of Justice of the European Union (CJEU) ruled against the validity of the Safe Harbor Privacy Principles, which had been used to justify the transfer and which stipulate that in the event of threats to US security, a clause allows the US authorities to access the personal data of European citizens. The CJEU’s decision, in turn, followed the conclusions of the Advocate General, , and invalidated the Safe Harbor, which according to Vossm “is a problem for more than 4,000 US and European companies that depend on the Safe Harbour Privacy Principles for the transfer of personal data to the United States.” It remains to be seen what actions the institutions and European and US companies will take following this decision.

On the other hand, even in the absence of a GDPR, the Google Privacy Policy case shows that EU member states have the tools to oblige the operator of a search engine to respect privacy and personal data protection laws. In this vein, a number of cases have led to the data protection authorities in Germany, Spain, France, Italy, the Netherlands and the United Kingdom imposing penalties on Google, including fines amounting to hundreds of thousands of euros. While the size of these fines is relatively small compared with Google’s annual turnover (€59 billion in 2014), they are examples of the more severe enforcement actions, based on the turnover of the companies sanctioned, which are foreseen in the European legislative proposals.

In France, the Commission Nationale de l’Informatique et des Libertés (CNIL – the French data protection authority) disagrees with Google about de-listing following the Google Spain decision by the CJEU. Since the court recognized this right in 2014, any person may request that the operator of a search engine erase the search results that appear in relation to their name. As a result, Google has received tens of thousands of requests from French citizens. It then proceeded to de-list results on its European search engine domains (.fr, .es, .co.uk, etc.). But it did not extend the de-listing to other geographic domains or to google.com, which any user can search. In May 2015, the CNIL requested that Google proceed with de-listing from all its geographic domains. Google, however, argues that this decision constitutes an infringement of the public’s right to information and is, therefore, a form of censorship. A CNIL rapporteur (the official who manages the case) will no doubt be appointed to resolve this issue.

While the EU is working hard to hammer out a jointly-agreed regulation on protection of personal data, its member states, such as France, continue to strengthen their legislative arsenals. On September 26, 2015, the government presented a draft document on the subject of a “digital republic”, comprising some thirty articles on the confidentiality of electronic correspondence, portability of files and open access to public data, for public consultation. Public consultation on the development of this document is an interesting approach, the effects of which deserve to be monitored.

This article, written by Gregory Voss, along with the articles “European Union Data Privacy Law Developments”, published in The Business Lawyer (Volume 70, Number 1, Winter 2014-2015); “Looking at European Union Data Protection Law Reform Through a Different Prism: the Proposed EU General Data Protection Regulation Two Years Later”, published in Journal of Internet Law (Volume 17, Number 9, March 2014); and “Privacy, E-Commerce and Data Security”, published in “The Year in Review”, an annual publication of ABA/ Section of International Law (Spring 2014), co-authored with Katherine Woodock, Don Corbet, Chris Bollard, Jennifer L. Mozwecz, and João Luis Traça.

Practical applications

The effect of GDPR on businesses will depend on the final text adopted by the EU. It is a certainty that greater accountability will be imposed on companies that manage personal data. Some companies will probably have to create new data protection officer posts (DPO) defined on a similar model to the “correspondant informatique et libertés” (CIL) in France. Companies specializing in conducting privacy impact assessments will also emerge. The author, therefore, advises business leaders to closely monitor developments in legislation protecting personal data, in order to be able to comply with new legislation as soon as it comes into force. He proposes raising the awareness of employees through training on data protection. Finally, companies will have to implement adequate procedures to comply with the legislation on personal data protection, including those that enable the data breach notifications that will be required by the GDPR.

Methodology

To produce these articles about data-protection legislation, the author has analysed many legal documents and “hundreds of pages of proposals, amendments and opinions”, especially those resulting from the work carried out by WP29, the independent EU working group on the handling of personal data. In his articles, he puts the proposals of European authorities to adopt a GDPR into perspective and offers practical advice for businesses. He has also examined the changes in opinion of various European bodies, the European Commission, Parliament and Council, and has studied the reactions of legislators to Edward Snowden’s revelations on electronic surveillance.

By Alain Klarsfeld

Between 2010 and 2012, three key Acts were promulgated, requiring businesses and administrations to make significant progress in terms of gender equality. The Act of 2011 focused particularly on gender balance on the administrative and supervisory boards of companies and public administrations. Here is an overview of the impact of this Act by the research professor Alain Klarsfeld.

Professional equality and the fight against discrimination: a mixed record for overall progress

Despite the laws and affirmative action in favor of employment equality and the fight against discrimination, only minor advances have been made in many areas. Companies have certainly gotten close to the legal quota of 6% required concerning employment for the disabled, whereas the proportion was barely 4% ten years ago, but this is still far from satisfactory. Regarding older workers, companies have also made real efforts to prolong their employment (+8% in 7 years), with a rate of 44.5% for 55-64 year-olds at the end of 2012, after a long period of stagnation during the 2000s. Among other positive developments, we should mention the creation in 2011 of an ombudsman (Défenseur des Droits), who joined the French High Authority for the Fight Against Discrimination and for Equality (HALDE) and whose role is to further the fight against discrimination by ensuring that access to one’s legal rights, now simplified and streamlined, is more effective.
However, the employment situation of young people remains a concern, and has not significantly improved. As an example, a young graduate with five years of higher education can take, on average, a year to find a first position, despite the legislative incentive known as the ” Contract between Generations*”. Similarly, the employment rate of people from immigration populations, whether first or second generation, has changed very little.

Unprecedented progress

There is nonetheless a silver lining to this rather gloomy picture: the entry of women into the governing bodies of companies and institutions: the supervisory boards. It all started with an Act of 2011 concerning the balanced representation of women and men on supervisory boards and also to professional equality, which provided for the progressive introduction of quotas as a step towards the feminization of the governing bodies of large companies. The goal was to reach 40% of women by 2017, made mandatory with financial and non-financial penalties in the event of non-compliance. This is a real cultural shift that has opened the way for women to play a major role.

The issue of quotas

Quota-based policies are not universally approved. In fact, they are frequently contested. Their implementation may even be counter-productive, as evidenced by the tensions around ethnic or caste quotas in India or Malaysia. There were no such quotas before 2008, when they were introduced by Norway, since followed by 11 other countries, but they have had an encouraging effect in favoring equality on supervisory boards. It might have been supposed that the women in these positions would be seen as lacking legitimacy. However, studies show that the operation and work of boards of directors are improved. Women who are genuinely recruited for their skills appear to be less conformist, ask more questions and make these bodies more dynamic.

This legal obligation has also had the effect of putting a stop to a damaging system of cooptation. The boards of directors tended to exist in isolation, coopting new members from among their acquaintances. The imposition of quotas has opened new horizons regarding professional recruitment processes, by head-hunters for example, who are now compiling databases of highly qualified women and offering them to apply to these positions. In the future, it would be a good idea to verify that the creation of directories of qualified people has led to the recruitment of more professional administrators overall, and not necessarily just women.

Positive trickle-down effect

Thanks to this Act, which imposes a “positive obligation”, offers have emerged for training as administrators, helping to make the role genuinely professional. In the years to come, it will be necessary to verify that the presence of women on boards of directors supports or provides leverage for parity in corporate executive positions, and that no further legislation is necessary to achieve parity. Already, outside the scope of the Act, major groups, including companies listed on the French CAC 40, have set themselves goals for the recruitment of female managers and top executives. This is less of a blunt instrument than an obligation to comply with quotas, but it will again be necessary to verify that its potential trickle-down effect in companies, at every hierarchical level, produces real progress.

* A scheme introduced in 2013 to help private companies create jobs, including permanent employment contracts for young people.

From an interview with Alain Klarsfeld and the chapter “Equality and Diversity in years of crisis in France”, co-authored with Anne-Françoise Bender and Jacqueline Laufer, published in the book “International Handbook on Diversity Management at Work – Country Perspectives on Diversity and Equal Treatment (second edition)”, May 2014.

Definition

Professional equality: This means the same rights and opportunities for both men and women, in particular as regards access to employment, working conditions, training, qualifications, mobility, promotion, work-life flexibility and remuneration (equal pay).

Methodology

The chapter “Equality and diversity in years of crisis in France”, published in 2014, provides an up-to-date overview of developments in France concerning professional equality and diversity since the first edition of the book “International Handbook on Diversity Management at work – Country Perspectives on Diversity and Equal Treatment” was published in 2010. The book is the result of an analysis of changes to the European and French legislative framework and of the various reports and publications on the subject, as well as of paying attention to and monitoring the work of think-tanks, associations and businesses that deal with the fight against discrimination and the importance of diversity, in and outside of Europe.

By Gaël Gueguen

Basing itself on results for Tour de France cyclists, this study shows that cultural differences between team members have no effect on performance, an observation which may also be valid, under certain conditions, for the workplace, where of the issue of diversity remains a subject of ongoing debate.

To what extent can one transpose certain well-known management concepts (such as team work, strategy, rivalry, etc.) to a sport, e. g. cycling, so as to better understand how it works, and, by extension, further our understanding of company life? A first attempt to answer that has been made in a study by Gaël Gueguen (assessed particularly in relation to the number of nationalities involved), that questions whether the cultural diversity of teams taking part in the Tour de France has an impact on their results.

Diversity as a risk for team unity

High level sport necessarily draws on the best resources, whether human or material. A high level team will seek out the best possible athletes for a given budget and thus attempt to recruit in the world market. In the case of the Tour de France, where the internationalization of teams has intensified in recent years, there was a notable reduction in the number of exclusively national teams entered by traditional ‘cycling’ countries such as France, Italy, Spain, Belgium and the Netherlands between 1987 et 2009, and a corresponding upswing in the number of teams comprising five and more different nationalities. This trend is continuing: in 2015 for the first time, a South African team included two Eritreans. This globalization of professional sport, however, is not without risk: cultural diversity can lead to coordination problems (problems of mutual understanding, for example, when different languages are spoken within a team) and have a negative effect on racers’ team spirit (differences in values or attitudes). This question is all the more crucial in cycling, a discipline where the vital need for sponsors and the international nature of competitions sometimes requires that foreign sportsmen be recruited simply because their countries are targeted by the sponsoring brands.

Cultural diversity has no negative impact on performance in cycling

Should we take care to only include sportsmen of similar cultures in high level teams, or can we drop the idea? Wouldn’t a group focused on a specific task requiring rare complementary resources and coordination in competitive situations (exceptional climbers, sprinters, ace cyclists, highly versatile leaders and so on) be weakened by too wide a diversity among its members? It would appear not. Cultural diversity has no impact on sports results. Cycling team coaches can select a cyclist for his worth regardless of nationality without worrying about strong cultural differences. A possible explanation for this is that the professionalism of cyclists and their managers compensates for any coordination problems. . Indeed, since everyone’s efforts are supervised and synchronized by a chief coach, the roles of all team members are clearly defined, and regular training also helps transform each cyclist’s tasks into a perfectly mastered routine.

From cycling to the world of business in a single step

A company is rarely made up of homogeneous human resources as regards gender, age, experience, nationality, salary, etc. Do such significant differences increase the performance of work teams or not? Analysis of studies on diversity in the workplace show contradictory results. Diversity of team members can in some cases, for example, increase creativity and improve decision-making (since the clash of different opinions can spark good ideas). In others, however, it can negatively affect unity, trust and communication with a corresponding increase in tension and conflict. Can the observation that diversity and performance in cycling appear not to be related, help us to better understand what is happening in the corporate context? No doubt, but only under certain conditions. The Tour de France competition is somewhat particular which makes it hard to generalize, firstly in that members of professional cycling teams are extremely specialized, and then that, in this most important cycling event, teams of only the nine best riders among the thirty-odd under contract compete with each other and not the entire group (which would, however, be the case for a company).

Nonetheless, the methodology used can easily be transposed for a study of the impact of cultural diversity in teams of top managers on the performance of multinationals. This is of interest now that more and more firms are diversifying their executive boards as they expand internationally. In a multinational company such as L’Oréal, for example, the recruitment of managers from different countries is considered to be the principal factor behind successful product-launches in emerging countries. To limit a ‘Tower of Babel syndrome’*, multicultural teams are organized around a leader who, through experience in a variety of countries, knows how to handle inter-cultural tensions.**

* Coordination difficulties arising from different languages spoken within a team.
** “L’Oréal Masters Multiculturalism” de Hae-Jung Hong et Yves Doz (Harvard Business Review, juin 2013).

References

The article “Diversité culturelle et performance des équipes sportives de haut niveau : le cas du Tour de France”, by Gaël Gueguen (Management International, 2011).

Practical applications

Although cycling is a somewhat particular activity, especially given that all its participants are highly specialized, the results of this research may be applied to the workplace provided that certain conditions are met. In groups comprising team members with clearly defined roles and specific tasks it may be stated that neither cultural diversity nor other differences such as gender, origin, age or education have a negative impact on collective performance. As with cycling, a specific team culture that transcends cultural boundaries may well arise.

Methodology

I analyzed the results of 487 teams (4,375 racers) taking part in 23 Tours de France between 1987 and 2009 in order to determine whether cultural diversity harms performance. The study was based on several factors which allowed me to determine the cultural heterogeneity of the teams (based, primarily, on the number of countries represented). The aim was to compare the performance of teams of cyclists (their results) with the level of cultural diversity via a linear regression analysis intended to measure the strength of the relationship between a series of independent variables and one requiring explanation.