Investing, Bonds, and the Network Effect
Many of the topics we have recently covered in class can be tied into the inner-workings of the stock market and other parts of the financial world. In a recent Yahoo! Finance article titled, “Why Muni Bonds Are Suddenly So Popular”, author Patti Domm explains this recent surge in popularity. Bonds have seen a rise in popularity over the last few years, mainly because they are shielded from gains and losses and general instabilities of the economy, which make them a rather attractive option in recessionary times.
With the recent results of the presidential election, however, tax increases are imminent and investors know this. By allocating their money toward fixed income securities such as municipal bonds, investors can safeguard their money from tax hikes. As more and more investors see other investors putting their money towards bonds, they will likely be more inclined to follow–thus illustrating a cascade. This phenomena can be explained by the informational effect, which says that as more and more people begin doing something, others will follow because they believe others know something that they do not. The central fear here, according to some experts, is that a bubble might begin to form as a result of the continued surge in investments in municipal bonds.
The wisdom of crowds and network effects come up all over the place and the financial sector is a perfect example of this. Stock prices, for example, often cascade (either up or down) as a result of an early group of investors buying or selling that particular stock. As the stock gets more popular, more and more people begin to gravitate toward purchasing that stock, regardless of whether they know much about the stock or why is is projected to rise or fall; they just follow the crowd. This is, in part, what caused the infamous stock market crash of the late 1920’s. Humans often rely on their gut instincts or “animal spirits” when making stock decisions and panic can move through them like the plague. Ergo, one could go so far as to say that the financial sector could be considered cascade-oriented.
Source: http://finance.yahoo.com/news/why-muni-bonds-suddenly-popular-164742730.html