What drives the stock market?(2)

Behavioral-finance theory holds that markets might fail to reflect economic fundamentals under three conditions. When all three apply, the theory predicts that pricing biases in financial markets can be both significant and persistent.

Irrational behavior.
Investors behave irrationally when they don't correctly process all the available information while forming their expectations of a company's future performance. Studies have shown that investors often put too much weightage and focus on recent events and results, regardless of the level of significance. This is an error that leads them to overprice companies with strong recent performance. Others are excessively conservative and underprice stocks of companies that have released positive news. Similarly, stock prices of companies tend to get oversold after 1 or 2 quarters of weak financial earnings.

Systematic patterns of behavior.
Even if individual investors decided to buy or sell without consulting economic fundamentals, the impact on share prices would still be limited. Only when their irrational behavior is also systematic (that is, when large groups of investors share particular patterns of behavior) should persistent price deviations occur. Hence behavioral-finance theory argues that patterns of overconfidence, overreaction, and overrepresentation are common to many investors and that such groups can be large enough to prevent a company's share price from reflecting underlying economic fundamentals—at least for some stocks, some of the time.

Limits to arbitrage in financial markets.
When investors assume that a company's recent strong performance alone is an indication of future performance, they may start bidding for shares and drive up the price. Some investors might expect a company that surprises the market in one quarter to go on exceeding expectations. As long as enough other investors notice this myopic overpricing and respond by taking short positions, the share price will fall in line with its underlying indicators.
However, this sort of arbitrage doesn't always occur. In practice, the costs, complexity, and risks involved in setting up a short position can be too high for individual investors, especially in singapore market, where the terms and conditions do not favour the short-sellers.