Information Cascade of Meme Stocks
We learned in class that an information cascade is a phenomenon where individuals base their decisions on earlier or prior people’s decisions rather than on their own knowledge. This essentially creates a chain of herd decisions, which can be particularly dangerous in various scenarios. For instance, information cascade is one of the biggest reasons why misinformation is so prevalent in social media platforms such as Facebook and Tiktok. If not equipped with a solid understanding of materials, individuals will often tend to believe in whatever other people say. Therefore, it is crucial to not let other people’s decisions take over one’s own decision-making especially in this technological age. With respect to financial markets, information cascades can pose a great threat to financial stability because they alter the stock prices nontrivially and create some sort of “stock fad”. In this blog, I will discuss some interesting statistics about investors in the modern age and how information cascades cause harm to the stock market.
In an article from Vanguard, it is stated that: “According to a recent survey, 12% of investors ages 18–34 learned how to invest from social media research, compared with only 3% of investors ages 35–64 and 1% of investors ages 65 and older.” This implies that younger investors invest in stocks not from a solid understanding of business/corporate performance but rather from advices from social media. Moreover, it is also found that thousands, if not millions, of young investors take advices from social media platforms such as Facebook and Reddit and share them with their peers. Therefore, an information cascade occurs in this fashion where young investors do not fully understand the stock market but invest anyway with the advices given through word of mouth. This causes a short-term price increase and eventually a crash. In other words, information cascades in stock markets introduce a noticeable instability and volatility to the market. As a matter of fact, this is how the GameStop craze began. People started buying GME stocks as a joke, and tons of people got on the fad, ultimately leading the price to increase to $347.51 per stock on January 27, 2021. However, the prices are now at around $200. This highlights the importance of making smart investing decisions rather than just believing what other people say and imitating others’ behaviors. According to the NYT article, the Fed declared that although recent episodes of meme stock volatility did not leave a lasting imprint on broader markets, few trends must be monitored to ensure financial stability and the resilience of the financial system. Thus, the takeaway of this blog is that one should not base one’s investment decisions strictly on fads because crash is inevitable and might affect the broader market as a whole.
Link 1: https://www.nytimes.com/2021/11/08/business/fed-meme-stocks-social-media-volatility.html
Link 2: https://investor.vanguard.com/investor-resources-education/article/whats-the-buzz-around-meme-stocks