The Impact of Information Cascades on Financial Markets
It is easy to go with the crowd. The herd. Perhaps, it is natural to human nature to think we are stronger together, more knowledgable together, than apart, than alone. That there is always someone smarter, more experienced, and that their opinion is probably the most reliable. In our modern day and digitalized age, information cascades represent this behavior and action in its purest form. In definition, information cascades occur when people are influenced to make decisions depending on the decisions of others, or the “crowd.” Because of this, the largest dependence of actions prominently fall on the first couple of people to make decisions. The first couple of people or parties, usually being experts, companies, or big organizations. They have the largest influence, because one a majority decision is made, the succeeding people will have a higher chance to fall into line or imitate them. It is not until any “new public information or precise information source” arrises that the direction of the information cascade will change. Therefore, people remain, for the most part, in the cloud of unknowing and bias caused by the herd.
According to Barclay Palmer, information cascades are at their strongest when there is no “verbal communication between individuals.” Key word: “communication.”
This is particularly evident in the cutthroat environment of financial markets in America. Normal people usually look to large investment banks, financial pundits, or Wall Street for guidance in where to delegate their stock picks and investments. Because many normal people lack a degree in some kind of economic or business field and may not be willing to put in the time or have the resources to research about logical and rational financial decisions, they simply put their trust into financial pundits. Once the “crowd” starts gaining momentum, it is easier for people to follow in mainstream decision-making. This is evident in the mid 2000’s housing bubble market crash. The mania of house ownership grew during this time, as “government policies [and banks] encouraged homeownership and a host of financial market innovations that increased the liquidity of real estate-related assets.” People started naturally began buying into this, and it kept spreading from neighbor to neighbor, person to person. Eventually it got out of hand to the point that the market crashed and led to the eventual impact of millions of foreclosures. Because of “crowd” mentality, significant damage and harm was caused to the public masses.
This relates to my networks class, because it follows the concept of information cascades, in which the masses follow the “crowd” decision usually started from the experts, and that information is continuously relayed sequentially so that everyone is influenced to make the same decision. If anything, I understood from this article and my class that people needed to be decisive and confident in doing their own work to make sure they are making justified decisions and not only going with the “crowd.” If they do choose to follow the “crowd”, then they need to carefully understand the reasoning behind the “crowd” or expert decisions, so that they are not just blindly misplacing their trust. This is where communication is extremely important. The “crowd” and experts also have a responsibility to vocalize how they made their decision and to also communicate when they have made detrimental decisions before it is too late. Thus, they can stop information cascades from causing additional mass harm to the public. However, this will require a sense of selflessness and honorability that is increasingly hard to find nowadays, as people and groups tend to act in their own self-interest. If we are to stop the negative effects of detrimental effects, we need to look out for our “own,” and experts and organizations need to “communicate” openly and amiably.
Finally, I would like to note that by following to mainstream action, this sacrifices any radical or diverse ideas that may be drowned out. No new information or voices will come into the conversation, because everyone is so blinded by the “crowd” voice. This goes a long way in stifling creativity and diversity in thought. We must reverse the effects of information cascades to ensure that we have plethora of ideas and options available to us. This way we can have more flexibility and be totally informed when making decisions.
https://www.investopedia.com/articles/investing/052715/guide-understanding-information-cascades.asp
https://www.investopedia.com/terms/h/housing_bubble.asp