Stock Recommendations By Investment Advisory Services: Immediate Effects on Market Price

T IS the hypothesis of this paper that one of the determinants of demand for individual securities emanates from the widespread practice among investment advisory services of recommending purchase of stocks. The question which this study considers is the following: What is the effect of a recommendation by an investment advisory service on the short-term changes in the market price of a stock? If such an effect is found to exist, what is its immediacy, its magnitude, its persistence, and its consistency for a group of recommendations? Implicit in the hypothesis is the assumption that increased demand for a stock resulting purely from recommendation would come from the "small investor" segment of the market. Those greatly involved in finance, particularly institutional investors, would not likely purchase a stock merely because of a review or recommendation by a widely distributed advisory service. Such investors might become interested in a stock in this manner and thus be motivated to add a stock to their list of potential investments. But it is probable that a more thorough analysis of the value and prospects of the stock would precede purchase. This study is particularly reliant upon those small individual investors who might accept the advice of an investment advisory service and buy a stock without prior or further investigation. Only one study could be found which concentrates on the particular problem of price effects of recommendations. This study, published in 1963 by Raymond T. Ruff,' dealt with twenty-nine "Stock of the Month" recommendations from Standard and Poor's Outlook for the period 1959 through 1961. Mr. Ruff concluded that an immediate price effect was evident as a result of the recommendation and that this effect lasted about seven trading days after the recommendation. On the eighth day, a declining trend became evident. Of the several additional studies of investment advisory services which have been made, nearly all have concentratecl on the quality of the recommendation as measured by longterm performance of the stocks in the market. The classical study of this area is that published by Alfred Cowles in 1933.2