What is Reflexivity?

John Spacey, updated on July 26, 2023

Reflexivity is the theory that biases and social proof influence both market prices and economic fundamentals. This is based on the observation that a popular company may receive a higher stock price than is justified by its fundamentals or future prospects. This stock price may allow the firm to raise money cheaply and may generate free publicity that opens up partnership deals and sales. This can become a positive feedback loop as prices go up the company's popularity and fanbase only grows.

An easy way to think about reflexivity is that an irrationally overpriced company can become a sort of self-fulfilling prophecy as its stock price can impact fundamentals.

According to mainstream economic theory, this isn't possible. In a highly competitive market, prices should always accurately reflect what is known about a firm's future earnings. The idea that a stock can defy market forces isn't considered possible. Traditional economics also doesn't typically model scenarios whereby irrational price action on a stock would end up impacting the economic prospects of a firm.

It should be noted that reflexivity can also be negative. An unpopular company may have an irrationally low stock price that impacts the ability of the firm to raise money or find partners and customers.

It is also possible for a firm to quickly swing from popularity to unpopularity. This typically occurs due to an inability to meet inflated expectations. The benefits of reflexivity, if they exist at all, are typically small as compared with fundamentals.

Overview: Reflexivity
Type	Investing Economics
Definition	The theory that biases and social factors can impact market prices and economic fundamentals and that this impact can be self-reinforcing as prices confirm biases and accelerate social processes such as popularity.
Status	Considered impossible by more conventional theories, particularly the efficient market hypothesis
Notes	Reflexivity can also apply to entire industries or markets such as periods of market optimism or fear that end up impacting fundamentals.
Related Concepts	Social Proof Cognitive Biases Feedback Loop Economics Investing