Finance and Positivism

Introduction According to Little (2005), philosophy of social science is a scholarly discipline that attempts to analyse the logic, methodology, modes of explanation of the social sciences, in which its studies include psychology, sociology, anthropology, history and economics. Social science provides understanding of everyday interactions of individuals and interactions among human society in social institutions. Providing prediction and explanation for human behaviour and its consequences are some of the main aims of social science (Rosenberg, 1988).
The purpose of this paper is to examine how philosophy of social science can help in explaining speculators’ behaviours. This paper is divided into five sections. It will begin by explaining the speculative behaviours of stock traders on lottery type of stocks, the probable data source and methodology. This will be followed by introducing the concept of positivism and identifying the reasons for selecting positivism. This paper will also provide some criticisms to positivism. Lastly, the paper ends with a summary.
Speculative Behaviours of the Stock Traders in Lottery Type of Stocks My research will be mainly focus on the speculative behaviours of the stock traders, such as fund managers and retail speculators on lottery type of stocks. Speculation is different from investment, in which according to Peers (2003), On the one hand, speculation involves taking large amount of risks attempting to earn quick profit. Speculation is a game where expected return and risk are both indeterminate.

As a result, speculators need to take relatively large amount of risk with respect to attempt to predict the future. A simple example of speculation is purchasing gold. Speculators might think that buying gold is a better use of money due to the inflation. Since gold depends more on inflationary rate and relies less on global economy, buy gold during period of financial crisis will help speculators to generate quick profit. However, gold prices are now extremely high, and there is no guarantee that prices will keep increasing in the future.
Since there are huge fluctuations in gold prices, speculators are very likely need to bear large amount of risk when they purchased gold. On the other hand, according to Taylor Frigon Capital Management LLC (2007) investment involves analyzing the future earning and the preference of participating in those future earnings. The expected future value of investment is higher than the cost of the investment. Expected future value takes into account for all of the potential good or bad events multiply by the probability of those events.
Investors usually search for definable expected future value, minimize risk and investors have nominal risk aversion, which means that investors will prefer a more guaranteed payout and the uncertain one, otherwise, investors will need a higher expected returns in order for them to undertake the risk. Using the gold example to differentiate investor and speculator, investors purchase gold and hold it for decades, because after couple of decades, the returns from selling those amounts of gold will be higher than the initial cost of buying those amounts of gold, even after subtracting the returns from the transaction costs.
Furthermore, gold will still be considered as one of the most precious metal after couple of decades. Investors do not need to worry that the value of gold will worth nothing, thus expected future value is more guaranteed and risk is minimized to some extent. Speculators purchase gold during the periods of financial crisis, and sell gold in order to buy stocks during periods of bubble. This strategy can help speculators to generate quick profit, however, it is extremely hard to predict when bubble or crisis will occur, and this uncertainty might cause speculators to experience huge amount of loss as well.
Lottery Type of Stocks According to Kumar (2009), some stocks are classified as lottery type because they have prominent characteristics of lottery. Lottery type of stocks has low prices and relatively high potential payoff, just like jackpot in lottery. The expected returns of lottery type of stocks are negative but low, and they have risky payoffs. The price distribution of lottery type of stocks has very high variance, and most particularly, the probability of earning a huge profit is extremely small.
Since lottery type of stocks has a very big probability of experiencing a loss and a very small probability to generate a huge gain, both risk and expected future value are indeterminate. By applying the definition of investors and speculators that we mentioned earlier, only speculators will have the preference of buying lottery type of stocks, due to their risk loving behavior, while investors do not, because risk-averse investors prefer to minimize risk even though there is a small change to earn huge profit.
Positivism One of the main topics in philosophy of social science is positivism. According to the Merriam-Webber’s Dictionary, “positivism” is a view of scientific methods and a philosophy approach that defines positive knowledge is based on natural phenomena and their properties and relations as verified by the empirical sciences, and defines theology and metaphysic as earlier imperfect modes of knowledge.
According to Perry, Riege and Brown (1999), some of the ontological assumptions of positivism are that the world exists externally, it is characterized by natural laws and it can be objectively observed by using a scientific way. In other words, positivism can be viewed as an appropriate methodology of social science, which emphasizes empirical observation. Positivism is also associated with empiricism, only the events, things or creatures that can be observed based on sense, experience and positive verification via the five senses can be considered as authentic knowledge.
According to Creswell (2003), the underlying epistemological assumption of positivism is that there is an independent researcher of the research project, who is value and bias free, and has no influence on the result of research or data collected. Furthermore, Ticehurst and Veal (2000) states that the methodological approach for positivism is restricted in term of explanation and discovery of facts. Researcher uses developed theories and frameworks to describe behaviours based on the observations and facts collected.
As a result, scientific, empiricist, experiental, deductive or quantitative approaches are involved in the research. In addition, Guba and Lincoln (1994) state that the paradigm stresses the value-free theory testing instead of theory building. Some of the key assumptions of the positivism paradigm, according to Phillips and Burbles (2000) include, first of all, researchers use null hypothesis because founded evidence in their research is usually fallible and imperfect. Secondly, majority of quantitative researches begin with the test of a theory.
Researches can be considered as a practice of making claims, and subsequently either abandoning or refining them. Thirdly, knowledge is shaped by the data, evidence and rational considerations. Furthermore, research attempts to develop statements those are relevant and true, in which they are able to provide descriptions and explanations for the situation or causal relationship. Lastly, one of the most important parts of a competent inquiry is to being objective. Data and Methodology
In order for lottery type of stocks to match the main characteristics of lotteries, first of all, the data will mainly focus on the stock with low prices (under one pound per stock). Within the set of stocks with low prices, my PhD research will focus on stocks with higher stock specific skewness, because these are the stock with higher potential payoff and they appears to be more attractive to speculators. Lastly, among the set of stocks with higher stock specific skewness and prices below one pound, my PhD research will focus on stocks with higher idiosyncratic volatility.
It is because stocks with higher idiosyncratic volatility are more likely to be considered as lottery type of stocks, because speculators might believe that when volatility is high, there is larger probability to realize the extreme returns that occurred in the past (Kumar, 2009). The methodology will be similar to Kothari and Warner (2006), in which the return of any given security at any given time can be obtained by adding the expected return based on expected return models, like Fama-French three factors model, to the abnormal return. The abnormal return of a given time eriod can be obtained by averaging all the abnormal returns of the given period. Given the test statistics provided by Kothari and Warner (2006), the paper will test the null hypothesis, comparing the returns of lottery type of stocks and index returns. If the test statistics are significantly lower, then the evidence may suggest that the returns of lottery type of stocks underperform index returns, or vice versa. Criticisms to Positivism Some of the criticisms to the positivism is that the ontological position of positivist vis-a-vis reality that social reality exists in an independent way to the researcher (Schutz 1954).
It is not helpful for the exploratory research, because the research attempts to understand meaning of the speculating process and varying perception of speculators. Berg (2004) claimed that people, events, objects and situation do possess meaning themselves; these elements confer meaning due to human interaction. Furthermore, it is inappropriate to ask the positivistic position on the epistemological question of “In what way one can obtain knowledge from a particular reality? ” due to the postulation that investigating in such a reality provides no change to that reality.
Moreover, one of the main criticisms of the positivism paradigm, according to Hussey and Hussey (1997), is that it is impossible to consider to people as being separate from the social contexts and they cannot be understood without apprehending their views of their own activities. A rigorously structured research design will impose some constraints on the results, and it might ignore more relevant findings, because researchers might carry their own value and interest to the research. The researchers cannot be objective because they are also part of what they are trying to observe.
Lastly, statistical variables could be misleading as it is trying to capture complex phenomena. Reasons for Selecting the Positivist Paradigm Positivism is chosen to fit my PhD project, because according to Phan (2006), first of all, ontologically, stock markets is a financial world in which investment decisions can be considered as an external world, objectively adjusting itself, and individual perceptions or desires cannot have any influence. Secondly, quantifiable results are mainly the concerns in the world of financial markets; it is impossible to make any alteration to the reality or to make any different perception.
Thirdly, epistemologically, the researchers should be independent of their research projects, in other words, they should be free of bias and personal value, and should have no influence on the collection of data or the results of researches. Moreover, one of the main objectives of the PhD projects is to test hypothesis regarding to the returns of indexes and returns of lottery type of stocks, not to construct new theory or to implement any reform. Lastly, objectivity is important in the financial world in order to provide explanation to phenomena and causal relationships.
To summarise, the PhD projects will be mainly focus on making measurements in a statistical and systematic way in order to provide validity, generalization, reliability for the measurements, as well as its predictive cause and effect (Casell and Symon 2004). Summary To sum up, my PhD research will be mainly focus on the speculative behaviours of the stock traders, such as fund managers and retail speculators on lottery type of stocks. The paper will be carry out using quantitative method and positivism fits very well in my research, as positivism is a methods that define positive knowledge which can be verified by empirical sciences.
There are some criticisms about the ontological and epistemological assumption of positivism, nevertheless, the benefits of applying positivism exceeds it costs as my PhD research will mainly focus on making measurements in a statistical and systematic way to predict the cause and effect of different research topics, as well as their validity, generalization and reliability of the measurements. Reference: Berg, B. L. (2004) Qualitative Research Methods for the Social Sciences. 5th Edition, Pearson Education, Inc. Boston.
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