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Learning from the Behavior of Others: Conformity, Fads and Informational Cascades

Learning from the Behavior of Others: Conformity, Fads and Informational Cascades. Bikhchandani, Hirshleifer and Welch. Journal of Economic Perspectives , 1998. Brilliant Marketing?.

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Learning from the Behavior of Others: Conformity, Fads and Informational Cascades

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  1. Learning from the Behavior of Others: Conformity, Fads and Informational Cascades Bikhchandani, Hirshleifer and Welch Journal of Economic Perspectives, 1998

  2. Brilliant Marketing? • In 1995 Michael Treacy and Fred Wiersema secretly purchased 50,000 copies of their business strategy book The Discipline of Market Leaders from strategic stores that were monitored to select books for the New York Times bestseller list. • Despite mediocre reviews, their book made the bestseller list.

  3. Questions Addressed • Why do people tend to converge on similar behavior in what is known as “herding”? • Why is mass behavior prone to error and fads” • What does the theory of observational learning have to do with economics and business strategy?

  4. Social Learning - An Old Idea Men nearly always follow the tracks made by others and proceed in their affairs by imitation. Machiavelli 1514 When people are free to do as they please, they usually imitate each other… A society which gives unlimited freedom to the individual, more often than not attains a disconcerting sameness. Eric Hoffer 1955

  5. Evolutionary Origins The propensity to imitate - an evolutionary adaption that has produced survival over thousands of generations by allowing individuals to take advantage of the hard-won information of others. (BHW, 1998) Female guppies are more likely to choose males to mate with whom they have observed being selected by previous females. (Gibson and Hoglund, 1992) Human infants mimic the observed behavior facial expressions of adults within minutes of birth.

  6. Social Conformity Birds Candid Camera Asch 2 min Asch 4 min Berns & Peterson Are all the explanations for mimicing (herding) the same?

  7. Causes of convergent behavior? • Individuals face similar decision problems, similar alternatives and similar payoffs

  8. Herding • Herding may arise when payoffs are similar even if initial information is not. • Here people communicate with each other or observe the actions of others—or the consequences of these actions.

  9. Formal Models of Information Cascades: Key Assumptions 1. Decisions/actions are made sequentially 2. Payoffs to actions taken are uncertain, but we lean about possible payoffs through “noisy” signals 3. We can observe the actions, but not their private information

  10. Decision Structure Should we buy a risky stock? A binary (yes-no) decision V = Payoff Accept (buy stock)  V = 1 or V = -1 Reject (Don’t Buy)  V = 0

  11. Information Structure Signals: High and Low Pr( V=1 | High ) = p conditional probabilities Pr( V=1 | Low ) = 1- p As p rises, signals are more informative p = 0.5 (1-p = 0.5) signals not informative p = 0.90 (1-p = 0.10) signals highly informative Example: V = 1 “rain in one hour” Signal: clouds or no clouds  high p Signal: heads or tails on coin toss  p = 0.5

  12. Information Structure Prior to receiving signals, both states equally likely:Pr( V=1 ) = 0.5 Pr( V= -1 ) = 0.5 People act sequentially (not simultaneous) People observe actions and not signals of others

  13. First in SequenceAaron Signal: High Signal: Low Reject(Don’t buy) Accept (buy stock) (V=1 is more likely) (V=1 is Less likely) All subsequent decision makers can infer what signal Aaron received (high or low) by observing his action (buy or not buy).

  14. Second In SequenceBarbara Aaron accepts & Barbara receives high signal Aaron accepts & Barbara receives low signal Flip coin Barbara accepts Heads: Barbara Accepts Tails: Barbara Rejects

  15. Third in SequenceClarence Aaron and Barbara both accept Aaron and Barbara both reject A (B) accepts and B (A) rejects Clarence follows own signal Clarence accepts even if signal=low Clarence rejects even if signal=high His adoption provides no info to successors His rejection provides no info to successors His action provides info to successors

  16. Terminology An Information Cascade begins when one agent’s optimal action does not depend on his private information, and the uninformativeness of the action means that no further information accumulates. An upward cascade occurs when a sequence of decision makers all accept. A downward cascade occurs when a sequence of decision makers all reject.

  17. Terminology A correct cascade occurs when the cascade and signals move in the same direction (e.g., high signals lead to upward cascades). A incorrect cascade occurs when the cascade and signals move in the opposite direction (e.g., low signals lead to upward cascades).

  18. Possible Scenarios Sequence of Signals H H L L Upward information cascade begins with Clarence L L H H Downward information cascade begins with Clarence H L L H 0.5 probability that Barbara accepts and Clarence begins an upward cascade

  19. Possible Scenarios Sequence of Signals H H L L L L L L L L H Upward cascade begins with Clarence, but is broken by the 11th person – a fashion leader (people with higher p) H H L L L L L The first two decision makers were wrong and an incorrect cascade begins with Clarence.

  20. Role of Signal Informativeness

  21. Results from a Veconlab Experiment signal Blue Cup decision Anderson and Holt (1996): In 79 out of 94 cases agents ignored private signals and followed the cascade.

  22. Applications Business strategy – firms should imitate each other rather than seek product differentiation. Kennedy (1997) shows that TV networks copy each other in show types (e.g., medical dramas). Alternative explanation of clustering in show type: Networks are responding to a common information signal (shifts in consumer tastes) that are observable to the network but not the econometrician. This will lead to commonality of behavior without imititation.

  23. Applications Crime – The decision to commit crime is influenced by observing the behaviors of others. Seeing a peer commit crime, a person perceives the probability of gain to be high and the probability of punishment and stigmatization to be low. (e.g. shooting sprees, kidnappings, etc.) Politics – People learn about political preferences of others by observing public protests, yard signs, etc.

  24. Implications for the “wisdom of the crowd” Collective decisions are most likely to be good ones when they’re made by people with diverse opinions reaching conclusions, relying primarily on their private information (Suroweiki, p. 57).

  25. Questions 1. What are the two reasons people mimic others? 2. Why do people wear ties?3. What is “pluralistic ignorance” and how does it affect the tendency to mimic?4. How can these theories of social learning explain the rise of Nazism in the 1930s? 5. Is imitation good or bad? 6. How might the tendency to imitate by the result of natural selection?

  26. http://www.tnr.com/article/books-and-arts/hedging-america?utm_source=TNR+Daily&utm_campaign=3c6077c6ed-TNR_Daily_011210&utm_medium=emailhttp://www.tnr.com/article/books-and-arts/hedging-america?utm_source=TNR+Daily&utm_campaign=3c6077c6ed-TNR_Daily_011210&utm_medium=email

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