Information cascades are source of financial markets instability
An information cascade is created when individuals give more weight to the choice others have made relative to their own personal assessment. Thus they may make a decision that is swayed by what others have done and goes against their own private leanings. This behavior may be rational in some scenarios if the crowd is considered to be more knowledgeable than the individual. Information.cascades are observed in many circumstances, including in financial markets.
Information cascades don’t necessarily lead to the optimal decision however. Since individuals are swayed by the actions of others but do not have visibility into the reasons why others behaved in a certain way, information cascades can be heavily influenced by the quality of the decisions made by the earlier participants. Similarly, the cascades can also be quite fragile. For example, new public information (even if insignificant) can quickly change the herd behavior.
Research in better understanding information cascades is complicated by the fact that actual participants in a real situation may behave differently from participants (often dominated by college students) in controlled lab studies. For example, in a study in the paper cited below, the researchers show that finance professional are less likely to be swayed by herd behavior compared to untrained lab-study participants since the former group relies more heavily on their relevant experience and expertise. Similarly, the researchers show that different groups of professionals may behave differently; for example, day traders may be influenced in different ways compared to longer-term investors. And of course the scenarios and decision settings that are studies in a lab setting may not capture key aspects of real scenarios.
http://www.nber.org/papers/w12767.pdf
http://www.investopedia.com/articles/investing/052715/guide-understanding-information-cascades.asp
https://en.wikipedia.org/wiki/Information_cascade