Information Cascade in the Stock Market
https://www.economist.com/democracy-in-america/2011/10/26/information-cascades
We’ve learned about how an information cascade starts and how it can affect future decisions made by individuals. Of course, these decisions aren’t just mindless copying, but rather an interesting phenomenon that occurs due to inference based off others.
This article from the Economist goes into detail about how information cascades can affect the stock market, where cascades can divorce an entity from any semblance of connection to underlying values. For example, Netflix was a company that did very well for such a long time that short interest was virtually non-existent. Traders inferred from other traders who were buying Netflix stocks that the correct move is to continue buying rather than selling, and thus shorting was the incorrect move. When stocks began to fall, without shorts supporting the price by covering, the stock plummeted, resulting in short interest skyrocketing. This phenomenon only served to drive stock down further, thus insinuating that stocks, rather than being based on the actual underlying value of Netflix itself, are based off the dominant opinion formed via information cascades.
At the time of the article, 17 eurozone countries were meeting in Brussels to try to prevent such a cascade from occurring in Southern European countries.
“If leaders fail to come up with an agreement, we’re likely to see those spreads jump again as they did in August. Traders will test the waters to see whether they can break the European Central Bank’s half-hearted commitment to keeping spreads low by repurchasing bonds in the secondary market. If some traders successfully short Italian debt, others will follow their example, and prices will plummet.”
When national economies are on the line, information cascades very quickly turn from interesting to scary. With how mercurial the market can be, leaders should hope that information cascades don’t cause devastating recessions in the future.