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Lemmings of Wall Street

Source: https://newrepublic.com/article/63023/wall-streets-lemmings

During one of the lectures, we went over one interesting game: suppose there is a box on the table; this box contains three balls, each with a color of either red or blue. You draw a ball and see its color for yourself; after you put the ball inside the box, you declare which color is the “majority” in the box. If you guess correctly, you earn some money; if you guess incorrectly, you lose your bet. This simple game sounds, well, simple. In fact, too simple that it seems inconsequential to ponder about dominant strategy: you declare the color of the ball you just pulled out as the “majority” color. When you are the only person who draws from the box, that is, in fact, the most rational thing to do. However, is it still the best strategy when the game is played by multiple other players? Say you are playing the game with two other friends of yours and you decided to be the last one to go. Your two friends each pulled out a ball from the box and, after looking at the color in private, declared that the red ball is the majority. Now it’s your turn; you went up and pulled out a ball: it was blue. What would you declare for the majority color?

Information cascade is ubiquitous, from simple choice of the restaurant to the collapse of the Berlin Wall and DDR (Deutsche Demokratische Republik; German Democratic Republic). And sometimes, its final result can be detrimental. An article from The New Republic, “Wall Street’s Lemmings” (written by Cass R. Sunstein), focuses on some of the toxic consequences information cascade had on American economy.

Sunstein mentions about subprime mortgage crisis (which in the article is referred to as “current crisis”, since the column was written in 2008) and delineates about how information cascade caused some of the similar fatal economic crises in America. People were affected by popular opinion that the housing price will continue to rise despite the economic statistics that indicated otherwise and jumped into the prominent social contagion. Mass media was one of the prominent components that formed a false “popular opinion”; when experts suggest one way, people took their words without much caution.

On the other hand, information cascade once caused people to grow weary of investment itself. Sunstein points out to the removal of $19 billion from American stocks and asserts that people’s “loss averse” (that is, people feel more miserable in loss than they feel happy in the same amount of gain) tendency made economic pessimism quite contagious. He mentions lemmings’ group suicide to describe such group blunder, driven mainly by the opinion of few others in the beginning.

Popular opinion is a good factor to consider when making a decision. In fact, information cascade can lead to beneficial results: heavily crowded restaurant probably signifies that it serves good quality food; high popularity of one product probably implies that it is innovational or well-made. Since the gamut of individual’s private information has limits, it is good to take others’ judgement into account when making one’s own decision. However, weighing others’ opinion too heavily may cause destructive result from ruining that night’s dinner to national economic crisis. Our primary job in decision making is, therefore, to find an effective way to balance between personal information and popular opinion–and probably to have more confidence in our ability to comprehend the world.

 

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