Information Cascades in Financial Markets
Information Cascades are often described as fragile and very brittle by nature because many individuals rely on herd behavior, making decisions based on the decisions of others rather than their own intuition. Any new public information given to the group could drastically change the majority of the decisions. These aspects of information cascades can also be applied to financial markets. When deciding what stocks to invest in, the average person might find it difficult to choose just a few companies or even find a couple companies that might be a good choice to invest in. While they could go off on their own research, many people find it a lot easier and less stressful to listen to the advice of trusted investors. Here the average investor could be investing in companies that they haven’t even heard of, yet still trusting the decisions of others.
These types of information cascades have translated into actual jobs and occupations with asset managers and financial advisors. Rather than reading articles online about certain stocks to invest in, individuals will hire professionals to give advice and insight into the markets and how to manage their investments. While this becomes less of an information cascade as communication between both parties is much more apparent, it is still an interesting concept to explore.
Some examples in recent history where the financial markets were greatly influenced by large information cascades include the recent Gamestop and AMC rush at the beginning of the year. Essentially what happened was Gamestop and AMC, both companies that relied heavily on foot traffic to bring in revenue, had been struggling due to the pandemic. Large hedge funds shorted the stock as they saw the companies had been performing poorly. A Reddit forum titled: WallStreetBets decided to purchase large quantities of the stock, causing the stock to go up, triggering an information cascade. Soon many individual investors were purchasing the stock without knowing why just hoping to reap some of the profits of the decisions of others with Gamestop’s fast-climbing prices.
https://www.investopedia.com/articles/investing/052715/guide-understanding-information-cascades.asp
https://www.youtube.com/watch?v=8D3NoigmsgA&ab_channel=ShaneHummus