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Information Cascades: Evidence From A Field Experiment With Financial Market Professionals

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Author Info
Alevy, Jonathan
Haigh, Michael S.
List, John A.

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Abstract

In settings characterized by imperfect information about an underlying state of nature, but where inferences are made sequentially and are publicly observable, decisions may yield a “cascade” in which everyone herds on a single choice. While cascades potentially play a role in a variety of settings, from technology adoption to social processes such as mate selection, understanding cascade phenomena is imperative for financial markets. Previous empirical efforts studying cascade formation have used both naturally occurring data and laboratory experiments. In this paper, we combine one of the attractive elements of each line of research—observation of market professionals in a controlled environment—to push the investigation of cascade behavior into several new directions. Numerous empirical insights are obtained; perhaps most importantly, we find that market professionals behave quite differently than a control group of student subjects. In particular, market professionals, more so than students, base their decisions on the “quality” of the public signal, leading them to be more likely to disregard “bad” signals. And, unlike in the case with students, for market professionals, the propensity to be Bayesian does not differ significantly across the gain and loss domains. These results have important implications in both a positive and normative sense.

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Paper provided by University of Maryland, Department of Agricultural and Resource Economics in its series Working Papers with number 28608.

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Date of creation: 2003
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Handle: RePEc:ags:umdrwp:28608

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Keywords: Financial Economics;

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Bikhchandani, Sushil & Hirshleifer, David & Welch, Ivo, 1998. "Learning from the Behavior of Others: Conformity, Fads, and Informational Cascades," Journal of Economic Perspectives, American Economic Association, vol. 12(3), pages 151-70, Summer. [Downloadable!] (restricted)
  2. Terrance Odean, 1998. "Are Investors Reluctant to Realize Their Losses?," Journal of Finance, American Finance Association, vol. 53(5), pages 1775-1798, October. [Downloadable!] (restricted)
  3. Sunil Sharma & Sushil Bikhchandani, 2000. "herd Behavior in Financial Markets - A Review," IMF Working Papers 00/48, International Monetary Fund.
  4. Bikhchandani, Sushil & Hirshleifer, David & Welch, Ivo, 1992. "A Theory of Fads, Fashion, Custom, and Cultural Change in Informational Cascades," Journal of Political Economy, University of Chicago Press, vol. 100(5), pages 992-1026, October. [Downloadable!] (restricted)
  5. Fama, Eugene F., 1998. "Market efficiency, long-term returns, and behavioral finance1," Journal of Financial Economics, Elsevier, vol. 49(3), pages 283-306, September. [Downloadable!] (restricted)
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  6. Fox, Craig R & Rogers, Brett A & Tversky, Amos, 1996. "Options Traders Exhibit Subadditive Decision Weights," Journal of Risk and Uncertainty, Springer, vol. 13(1), pages 5-17, July.
  7. E.K. Berndt & B.H. Hall & R.E. Hall, 1974. "Estimation and Inference in Nonlinear Structural Models," NBER Chapters, in: Annals of Economic and Social Measurement, Volume 3, number 4, pages 103-116 National Bureau of Economic Research, Inc. [Downloadable!]
  8. Banerjee, Abhijit V, 1992. "A Simple Model of Herd Behavior," The Quarterly Journal of Economics, MIT Press, vol. 107(3), pages 797-817, August. [Downloadable!] (restricted)
  9. David Genesove & Christopher Mayer, 2001. "Loss Aversion and Seller Behavior: Evidence from the Housing Market," NBER Working Papers 8143, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  10. John A. List, 2003. "Neoclassical Theory Versus Prospect Theory: Evidence from the Marketplace," NBER Working Papers 9736, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  11. Kahneman, Daniel & Tversky, Amos, 1979. "Prospect Theory: An Analysis of Decision under Risk," Econometrica, Econometric Society, vol. 47(2), pages 263-91, March. [Downloadable!] (restricted)
  12. John A. List, 2003. "Does Market Experience Eliminate Market Anomalies?," The Quarterly Journal of Economics, MIT Press, vol. 118(1), pages 41-71, February. [Downloadable!] (restricted)
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  1. Hongbin Cai & Yuyu Chen & Hanming Fang, 2007. "Observational Learning: Evidence from a Randomized Natural Field Experiment," NBER Working Papers 13516, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  2. Steven D. Levitt & John A. List, 2008. "Field Experiments in Economics: The Past, The Present, and The Future," NBER Working Papers 14356, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  3. Antonio Guarino & Marco Cipriani, 2008. "Herd Behavior in Financial Markets: An Experiment with Financial Market Professionals," WEF Working Papers 0047, ESRC World Economy and Finance Research Programme, Birkbeck, University of London. [Downloadable!]
    Other versions:
  4. Mathias Drehmann & Jörg Oechssler & Andreas Roider, 2004. "Herding with and without Payoff Externalities - An Internet Experiment," Bonn Econ Discussion Papers bgse15_2004, University of Bonn, Germany. [Downloadable!]
    Other versions:
  5. Randall Morck, 2009. "Generalized Agency Problems," NBER Working Papers 15051, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  6. Katya Malinova & Andreas Park, 2009. "Liquidity, Volume, and Price Behavior: The Impact of Order vs. Quote Based Trading," Working Papers tecipa-358, University of Toronto, Department of Economics. [Downloadable!]
  7. Weizsäcker, Georg, 2008. "Do We Follow Others When We Should? A Simple Test of Rational Expectations," IZA Discussion Papers 3616, Institute for the Study of Labor (IZA). [Downloadable!]
  8. Menkhoff, Lukas & Schmeling, Maik & Schmidt, Ulrich, 2008. "Are all professional investors sophisticated?," Diskussionspapiere der Wirtschaftswissenschaftlichen Fakultät der Universität Hannover dp-397, Universität Hannover, Wirtschaftswissenschaftliche Fakultät. [Downloadable!]
  9. Andreas Park & Daniel Sgroi, 2008. "When Herding and Contrarianism Foster Market Efficiency: A Financial Trading Experiment," Working Papers tecipa-316, University of Toronto, Department of Economics. [Downloadable!]
    Other versions:
  10. Randall Morck, 2008. "Behavioral finance in corporate governance: economics and ethics of the devil’s advocate," Journal of Management and Governance, Springer, vol. 12(2), pages 179-200, May. [Downloadable!] (restricted)
  11. Vivi Alatas & Lisa Cameron & Ananish Chaudhuri & Nisvan Erkal & Lata Gangadharan, 2006. "Subject Pool Effects in a Corruption Experiment: A Comparison of Indonesian Public Servants and Indonesian Students," Department of Economics - Working Papers Series 975, The University of Melbourne. [Downloadable!]
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  12. Park, Andreas & Sgroi, Daniel, 2008. "Herding and Contrarianism in a Financial Trading Experiment with Endogenous Timing," The Warwick Economics Research Paper Series (TWERPS) 868, University of Warwick, Department of Economics. [Downloadable!]
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  13. Burnham, Terence C. & Cesarini, David & Wallace, Björn & Johannesson, Magnus & Lichtenstein, Paul, 2007. "Billiards and Brains: Cognitive Ability and Behavior in a p-Beauty Contest," Working Paper Series in Economics and Finance 684, Stockholm School of Economics. [Downloadable!]
  14. Hirshleifer, David & Teoh, Siew Hong, 2008. "Thought and Behavior Contagion in Capital Markets," MPRA Paper 9164, University Library of Munich, Germany. [Downloadable!]
    Other versions:
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