Information Cascades in the Economy and Elsewhere
Information cascades can be seen in a wide range of forms in today’s society. One of the most obvious of these is in the economy. As the article I linked points out, information cascades can have huge effects on stock prices. One specific company highlighted by the article is Netflix. Over time, the share price of Netflix stock has had huge swings both up and down at times where the overall market was more or less stable. These can be partially explained through information cascades. The stock price would start rising a small amount for whatever reason, which investors would notice. They might not have any specific personal knowledge that would have encouraged them to buy the stock previously, but if the price is going up that means others are buying it so maybe they know something that you don’t. This starts a chain reaction as more and more people notice the stock price is rising and try to jump in to profit off the momentum, which in turn drives the price up even more. This effect could turn what would have been only a minor price swing into a massive climb in share prices.
The same effect can also be seen on stock prices in the opposite direction If a stock’s price were to take a slight dip, some investors may panic with the belief that the trend could continue. They may sell thousands or millions of dollars worth of shares to avoid the risk of the stock’s price dropping even further. This would also be noticed by other investors, who may think that the first group of people to sell their shares have information that leads them to believe a greater price drop is going to happen, so in turn they may sell their shares too and drop the price further. As explained above in the reserve scenario, this effect could continuously compound and cause a stock’s price to plummet in a short amount of time, even if the cascade was started by a false assumption or incorrect information. The effect of information cascades can apply not only to individual stocks, but can also be seen in the market as a whole. Major stock market crashes are made worse by people imitating the actions of others and selling off their investments, even when they have no information outside of the actions of others that would motivate them to do so.
Further applications of information cascades mentioned by the article include things like protests. The Occupy Wall Street movement began in New York City as a way to protest income inequality, which rapidly grew into an international movement against social and economic inequality all over the world. Within months, protests grew from in New York City alone to dozens of different cities across the globe. People who were on the fence about the issues that the movement focused on may have observed the thousands of others expressing their beliefs and been influenced to the point where they decided to join the movement. On their own, the individual probably would have never felt the urge to join the protest, but when influenced by the actions of such a large group, they may think and act differently. The article also highlights the fact that today’s technology has led to this effect being stronger than it ever has. Before the internet, people in Europe may have felt very little influence from the actions of protesters in New York City, but with how interconnected the world has become through technology, geography matters much less. In a time when everybody has access to such an enormous amount of information due to the technology that we have, information cascades have the potential to have larger and larger effects on the way people think and act.
http://www.economist.com/blogs/democracyinamerica/2011/10/mass-movements