Information Cascade in the Markets (Post-Election)
https://theconversation.com/what-we-can-learn-from-markets-reaction-to-a-president-trump-68116
http://www.bloomberg.com/news/articles/2016-11-08/stocks-higher-with-mexican-peso-as-vote-count-nears-yen-weakens
For weeks and days before that fateful day on Nov 8th 2016, the general consensus was that Hillary Clinton was going to be the next President of the United States. The question was not whether she would win the election, but how much was she going to win the election by?
When I went on to social media, there must have been at least 10 different articles determining that victory for Mrs Clinton was the only possible outcome that night. This begs the question, when did opinions and factual reporting stop, and where did the information cascade begin? Blinded by the rhetoric that Trump had been going on about during his campaign, few actually recognised the information cascade that was going on in the media regarding Clinton’s ‘decisive’ lead over Trump.
Similarly, markets were latching onto this information and pricing themselves in a manner that reflected this. On the morning of the election, when Clinton was purported to have more than an 80% chance of victory, the markets were priced to account for her track record of stability and efficiency. This had been going on for weeks leading up to the election, markets had been correcting and equilibrating to account for an assumed Clinton victory. By night time however, as Trump began to turn the electoral map into a sea of red, the market was thrown into a frenzy. The S&P 500 went down by 5%, and actually hit its loss limit (it was not allowed to go any lower than this),
So what actually happened? I think it’s a combination of two factors 1) the information cascade reiterating and reinforcing that Clinton would be victorious, led markets to price in a Clinton victory way too early and too emphatically, leading to a massive over-correction and overreaction when Trump surprised the world.
2) Many people (especially casual investors) had been overwhelmed by the negative reporting and portrayal of Trump in the media, social media, news articles and the like. What I believe happened was an irrational linking of this outcome to the tanking of the American economy: an assumption that if he won, the American economy would go down with him, and that it would be prudent to get out of any position as soon as possible.
Now this is not a political blog, so I will not get into any discussion on that. However, I think it is fair to think through what should have been the frame of mind for any investor looking at the results of the election. Donald Trump, with his huge business background and love for money, would rather naturally be a supporter for deregulation in the financial industry and less restrictions overall. So instead of the markets reacting negatively to the result, shouldn’t the markets have gone up in response to this shock result?
Instead, what I believe happened was that people grossly overreacted to the information cascade; seeing that the index dropped only fuelled their worst fears and made them contribute more to the decline, leading to the huge drop to the limit that we witnessed. Only when calmer, perhaps more rational sentiments prevailed, did the market rebound strongly and even hit positive (hence explaining the huge swing), upon realization that Trump’s victory might have been good for the markets. This itself, could be considered a cascade, as more and more people realised that the market overreacted and overcorrected, and hence rushed to back the market once more.
Through this election, we could therefore see how information cascades worked in real life, and led to immense volatility in the markets as a result of said cascade.