Information Cascades and Netflix
https://www.economist.com/democracy-in-america/2011/10/26/information-cascades
If you ask any college student what they do in their free time, the most consistent leisure activity that is reported is watching some online-streamed media. In this case, when we think about streaming media, Netflix is the first media provider that we think of. In a study done by LendEDU, 92% of college students have access to a Netflix account, and watch content on it regularly. With Netflix being such a popular media platform, one would think that its stock would be highly sought after and expensive. Even for those with no knowledge of how the stock market works, there is general understanding that the more valuable a good or service, the more people that will buy it – the same idea applies to stocks. It’s confusing, then, that Netflix stock is one of the most volatile stocks out there, with consistent deep plummets and high peaks. What is the cause of this? Netflix quality hasn’t necessarily gone down, prices haven’t gone up by much, and there have been no corporate scandals. The Economist states the volatility of Netflix stock is the result of information cascades and their effect on the behavior of stock buyers.
As we learned in class, an information cascade can occur when people make decisions sequentially, with later people watching the actions of earlier people, and from these actions inferring something about what the earlier people know. We can apply this same thought process to Netflix stock. For Netflix, its stock was incredibly robust for a long time, consistently growing until January 2018. Up until January there was a steady upward increase, with very few dips; any dips in stock were minuscule compared to after January 2018. In January, the stock started to dip, which led to a 13% drop in the stock value. The reason for this was because investors, having only seen Netflix stock steadily increase, became alarmed when stocks started to dip. As individuals began selling their shares, other individuals viewed the stock dumps as some sign that Netflix stock was tanking. They inferred that earlier people knew something about Netflix that they didn’t, and subsequently followed the information cascade.
According to The Economist, “the stock price became a freelance entity divorced from any semblance of corporate fundamentals”. This means that there were not necessarily any corporate signals indicating that the company was in danger, or that there would be reason to sell shares of stock. We can envision it like this: the Netflix entity was producing a high signal, with high signal indicating that there were no issues with the company; a low signal would indicate a corporate problem that justifies stock dumping. So, barring the first group of people that decided to sell their shares (most likely shorting shares to make quick profit), the rest of Netflix investors received high signals from Netflix, but saw that many other before them sold their shares, indicating that they had witnessed low signals. This is the information cascade. The first people made the decision to sell their shares of Netflix stock, which indicates to the others following that they received some low signal to prompt this action. Because many people started selling their shares, those following decided to also follow what the others before did, and sold their shares, regardless of the actual signal they received. Though we focused on the dip in Netflix stock, the same information cascades can be witness when Netflix stocks go up.
Thus, information cascades can be used to explain and characterize volatility in the stock market, in this case Netflix stock. Information cascades can be extremely detrimental, as well as beneficial, to companies as the domino effect of buying and dumping stocks can be based off a small group of initial influencers whose behavior is observed and copied by subsequent investors. But information cascades aren’t just limited to stocks – the Economist piece also outlines how information cascades were the causes for revolutions, regime transitions, and movements such as the occupy movements. The Economist points out how information cascades affect many types of stock, and that the effect of information cascades on human behavior is huge. The idea of information cascades, the fact the people watch others’ behaviors for insight into how they themselves should act, are the driving force behind group action and many of the group-behavior phenomena that we witness.