Information Cascades and Social Learning in Financial Markets
When formulating our opinions and making choices, as humans, more often than not we rely on the information of others to make these decisions and conclusions. We tend to put aside what we truly believe our gut is telling us and go with what the greater population thinks. This causes the potential for an information cascade to form which is when people make decisions sequentially from what people earlier decided.
However, before a cascade is formed people are engaging in social learning which is when people begin to observe others (essentially learning from them) behaviors they begin to behave like them and follow in their lead. Social learning and information cascades work hand in hand. By us learning through others actions our decisions are now influenced by one another which lead to information cascades.
This is something seen often in financial markets. Experts in trading are extremely influential on the market and on others trade decisions. A regular person is going to trust an expert in the field more than they are going to trust their own decision on a trade, thus resulting in them following a signal from the expert trader. This is extremely common to see nowadays even on social media. There are experienced traders that advertise their signals to be extremely accurate and these influencers follows usually end up paying for a subscription to these traders signals group chat. The idea is the trader will send out their signals on whether to buy or sell a specific stock and the rest of the group chat executes the same trade. The trader also encourages people to post their profits in a channel on the group chat so others can see the profits being made by regular people. The idea is to eventually influence others to join the group chat and follow the trades resulting in a cascade. However, this can be extremely risky because the trade can cause great financial losses in the long run if the expert isn’t necessarily a knowledgeable person in the field.
https://www.investopedia.com/articles/investing/052715/guide-understanding-information-cascades.asp
https://www.nber.org/system/files/working_papers/w28887/w28887.pdf
https://www.cs.cornell.edu/home/kleinber/networks-book/networks-book-ch16.pdf