Facebook Friends Can Make You Poor

Talk, Talk, Talk

Economists have had an extraordinary new idea. They’ve noticed that people communicate with one another and this has opened up a new line of analysis. Maybe these social interactions are somehow important in investment decisions?

Alright, enough sarcasm. The likely involvement of social interaction in causing the diffusion of investing ideas has been around for a while, but is only now catching up with the social networking phenomena. Behind this lies an insight that’s obvious when you’ve had it, but not before: the better your returns the more likely you are to broadcast your results.

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Herd of Investors

Bovine and Asinine

It seems sort of obvious that investors, a generally bovine group when not in asinine mood, will tend to congregate in herds and then charge about randomly, often over the edge of the nearest cliff. If this is true, however, it poses a set of puzzles that it’s not clear that any of the current approaches to understanding mass market behaviour can properly explain.

Certainly this behaviour isn’t efficient in the sense of obtaining the right price for a security, because deciding what to do based on the person running about in ever-decreasing circles next to you doesn’t come close to propagating useful information. However, if investors are irrational in herds then this implies that somehow their behaviour is synchronised and it’s certainly not clear that the simple set of isolated psychological biases that analysts currently work with is anywhere near sufficient to explain this.

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