No investigation, no risk?

When a government announces it will start a probe to investigate some certain sectors, the market usually will immediately lower its expectations in these about-to-investigated sectors. Such sudden shifts in market expectations are understandable and reasonable to many of us; however, when such shift is too large, I think that it is a mistake made by the market.

When a government decides to step into a sector to conduct an investigation, as long as the government has access to more information than the market does, then a decrease in the market expectation is reasonable as the market believes that the information which is known to the government but unknown to the market shows that the probability of wrongdoing in the sector is greater than the market expectation and is significant enough for the government to take actions. Under such circumstance, the market could lower its expectation as it is reasonable to believe the risk is greater than the market expectation, but before the result is announced, the market cannot be certain about how great the risk can be; therefore, a decrease in the market expectation is reasonable, but a sharp decrease does not accurately represent the government expectation. Although it is impossible for the market to change its expectation perfectly to the government expectation, as some information is still unknown to the market, the market can see the signal sent by the government to estimate the government expectations.

On the other hand, a sharp change in the market expectation shows that the market does not fully take the possibility of a government investigation into account. Each market has its unique characteristics and level of regulation and risk to the entire economy, based on these factors, the market could know the risk of wrongdoing in the market and how much the government attention on the sector is, thus they could estimate the possibility of a government conducting an investigation in the sector.