Information Cascade-2008 Crisis
Let’s talk more about information cascades. It’s really important to talk about these information cascades because they can cause us to lose a lot of money. For example, going back to the 2008 crisis, the crisis was essentially the result of an information cascade. Everyone trusted the rating agencies because everyone else before them trusted the rating agencies, to determine the safety of mortgage backed securities.
Turns out, actually most of these mortgage backed securities were much overvalued just due to social proof. No one questioned their inherent value and as a result, when the true value was realized, many banks lost money as mortgage defaults increased. Bank clients were hurt immensely as well.
This is a classic example why information cascades can lead to negative results. When people just rely on other people’s opinions and don’t do their own research, information cascades result. Next time, you deal with your money, be sure to do your own research.
What is an information cascade? An information cascades is when people trust others and take action based on earlier opinions of products/ideas/services over their own inferences and research. This is very relevant to class because as we learned, information cascades allow for network effects, which often determine the success of a product/service. Furthermore, network effects also determine the total fraction of a population that uses a product/service.
Link: http://economistsview.typepad.com/economistsview/2008/10/informational-c.html