Sunday, July 21, 2013

Bandwaggons and herding

The Economist assess why missing out on one job application is bad news for your chances in the next.

"The existence of bandwagon behaviour can be hard to prove. A product or an asset usually becomes popular (or unpopular) in the first place because it is genuinely superior (or inferior). But some have tried to isolate the self-fulfilling effects of popularity. One 2004 study* by Alan Sorensen, now of the University of Wisconsin, examined accidental omissions from the New York Times bestseller list"

As with the carry trade, there is some underlying effect but it is magnified by the attempt to deal with asymmetric information. This magnification causes a distortion that can eventually be significant.

Two decades ago Abhijit Banerjee, now at the Massachusetts Institute of Technology, devised a model of “rational herding” in which market participants base their decision on a combination of their own information and the actions of others. Over successive rounds of transactions, participants responded less to their own information and more to the herd.

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