Information Cascades: Their Influence on the Mexican Peso in the 2008 Financial Crisis
https://kuscholarworks.ku.edu/bitstream/handle/1808/16812/Vachalek_ku_0099M_13550_DATA_1.pdf;sequence=1
In class, we have discussed the concept of information cascades and the idea that information quickly diffuses amongst a tightly linked groups as information is shared by amongst nodes in the group. We have talked about an information cascade occurring as people make decisions and choices by observing and gaining information through the choices of other people. The concept of information cascades can be applied to many situations, from financial markets to politics. We have also talked about herd behavior.
The article I found relates to this concept in a fascinating way by analyzing the impact of information cascades on the value of the Mexican peso during the 2008 global financial crisis. According to the article, the Mexican government had placed many economic policies prior to the financial crisis to keep stabilize inflation and currency due to the country’s “exposure to currency crisis”. Despite these policies, the 2008 financial crisis significantly caused the value of the peso to plummet as investors speculated about how the American economy would impact Mexico, showing that “the uncertainty and negative sentiment within the market during the initial week of the global crisis played a stronger role in the rapid depreciation and recovery of the peso than changes in market fundamentals”. In other words, speculations about the future of the Mexican economy may have resulted in information cascades amongst investors.
The article then goes on to explain how specifically information cascades had implications for the peso and emphasizes that economic policy alone aren’t sufficient to prevent economic crisis due to the huge threat of information cascades, especially as social media emerges as the primary source of news and market sentiment. Furthermore, the author suggests better management of social media news mediums to prevent a cascade of investor pessimism which in this case caused the Mexican peso to lose a lot of value. For example, the article states that “the rapid flight of capital away from both Mexico’s peso and stock without obvious cause indicates that perception was creating the panic, rather than the real economic conditions within Mexico” and goes on to explain how uncertainty, which would of course be prevalent in financial crisis, leads investors to seek new information and reassess their beliefs, assumptions and knowledge, making herd behavior and the creation of information cascades almost inevitable.
Clearly, the phenomena of investor herd behavior in the financial crisis influencing the Mexican peso relates clearly to the concepts of information cascades studied in class. In this case, the uncertainty caused by poor economic conditions likely caused investors to speculate and follow each others behavior and transmit investor pessimism through a cascade which harmed the peso.