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The House Bubble of 2008, and Its Information Cascade

Attached above is a link for the article referenced.

The housing bubble of 2008 was a bubble formed by various factors. Junk bonds, subprime mortgages, and information cascades all played a role in the boom and eventual downturn of the US housing market. The mentioned article explains how the housing crash was not due to one large bubble, but “a froth- lots of small local bubbles that never grew to a scale that could threaten the health of the overall economy,” as said by Alan Greenspan, ex-chairman of the Federal Reserve. In essence, it explained information cascade in the same manner as described during lecture. If person A buys a house, incorrectly buys at an overvaluation, and person B does the same, this indicates the start of an information cascade. Each successive person will now hold their private information at a lesser value than if they were to buy a house independently (without consulting prices from other buyers in the market).

This example explains how market efficiency can not always be relied on as being completely objective, with each person voting independently in order to shift the optimal price incrementally lower/higher. In reality, information cascades explain to us how human interaction in real life distorts economic theory, and how human sentiment, media, and feelings can all affect the decision-making of otherwise rational human-beings. Bubbles function in a sort of self-fulfilling manner. Market bubbles inflate to a larger and larger extent the more people jump on board, and this is explained substantially by information cascading. For every additional member, this gives a potential buyer a false sense of security that alludes to “more people=more security in the investment” Unfortunately, this is not true in all cases.


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