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Information Cascade Effect on Netflix Stock Price

An article in The Economist offers an interesting perspective on the volatility of Netflix stock. Back in 2011, Netflix’s stock took a sharp drop in a period of just 3 months.  However, the author brings up the point that this sharp drop has nothing to do with Netflix itself, but has everything to do with its stock price.  When people sell a stock that is falling, the price usually decreases.  Likewise, when people buy a stock that is rising, its price usually increases.  Netflix’s price had been steadily increasing for about a year and a half, and there was little shorting of the stock.  Because of this, when the stock started to fall, it fell at a quick rate.  As a result, the stock became very unpredictable and had no definitive actual value.

This article truly showcases the instability of information cascades. When people first began to short Netflix stock, everyone kept losing money instead.  As a result, no one wanted to short Netflix stock because of the signals from the investors who lost money.  This cascade effect resulted in a small amount of shortening of Netflix’s stock, which created this sharp decrease in stock price.  When the price started to go down, short interest went up, which created an opposite cascade effect.  Now everyone wanted to try to make money off the stock while it was going down.  Thus the cascade effect of shorts influenced the price of Netflix stock price, not the actual company itself.

http://blogs.reuters.com/felix-salmon/2011/10/25/why-netflix-stock-is-so-volatile/

http://www.economist.com/blogs/democracyinamerica/2011/10/mass-movements

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