Investors Systematically Misjudge Correlated Information, New Wharton Research Finds

When multiple signals point in the same direction, investors treat them as independent confirmations rather than recognizing they might stem from the same underlying cause—a behavioral quirk that helps explain persistent patterns in stock market returns, according to new research from the Wharton School.

The phenomenon, which Wharton finance professor Jessica Wachter and co-author Hongye Guo call "correlation neglect," represents a fundamental challenge to how finance theory assumes investors process information. For CFOs navigating capital markets and managing investor relations, the findings suggest that market reactions to corporate disclosures may be less rational than traditional models predict.

In their paper "Correlation Neglect in Asset Prices," published this month, Wachter and Guo identify a striking pattern in U.S. stock market returns tied to how investors interpret multiple pieces of information. The research reveals that when investors receive several signals about a company or the broader market, they tend to treat each signal as an independent data point—even when those signals are actually correlated and therefore contain less unique information than they appear to.

Here's the thing everyone's missing: This isn't just about individual investors making mistakes. The research suggests this behavioral pattern shows up in aggregate market returns, meaning even sophisticated institutional investors fall prey to the same cognitive trap. (Which is, I should note, both fascinating and slightly terrifying if you're the CFO trying to predict how the market will react to your quarterly earnings.)

The implications extend beyond academic theory. When investors neglect correlation, they effectively double-count information that comes from the same source. Think of it this way: If an analyst report, a news article, and a blog post all cite the same underlying economic data, treating all three as independent confirmations makes that single data point seem three times more significant than it actually is.

For finance leaders, this creates a peculiar challenge. The research suggests that markets may overreact to clusters of related information—multiple analyst downgrades stemming from the same concern, for instance, or a series of news articles about the same underlying issue. Conversely, when information sources genuinely are independent, the market might underweight their combined significance because investors have learned to be skeptical of apparent consensus.

Wachter, whose research focuses on behavioral finance and asset pricing, has essentially identified a systematic flaw in how markets aggregate information. The paper examines U.S. stock market data and finds patterns consistent with investors treating correlated signals as independent, leading to predictable distortions in how prices respond to news.

The research arrives at a moment when CFOs face an increasingly complex information environment. With real-time data, social media amplification, and algorithmic trading, the same piece of fundamental information can generate dozens of seemingly independent signals within hours. If Wachter and Guo are correct, this proliferation of correlated signals may be systematically distorting price discovery.

What makes this particularly relevant for corporate finance leaders is the asymmetry it creates. Company insiders know which pieces of information are truly independent and which are just the same news refracted through different channels. The market, apparently, struggles with this distinction. That gap between internal understanding and market interpretation represents both a challenge for transparent communication and a potential explanation for why stock prices sometimes seem to overreact to what management views as non-news.

The broader question this research raises: If even sophisticated investors systematically mishandle correlated information, what other assumptions about market efficiency need revisiting? For CFOs managing everything from capital allocation to investor guidance, the answer matters more than just academically—it shapes how they should think about market reactions to their decisions.