learning from the behavior of others - conformity, fads, and informational cascades

Learning from the Behavior of Others - Conformity, Fads, and Informational Cascades Sushil Bikhchandani, David Hirshleifer and Ivo Welch

1

INTRODUCTION

- Reports of actions or endorsements often influence the reactions and purchases of others

o Bestseller lists, “claques”, professional mourners, restaurant seating

- Main argument:

o Learning by observing the past decisions of others can help explain some otherwise

puzzling phenomena about human behavior (…) and the theory of observational

learning has much to offer economics and business strategy.

- Questions:

o Why do people tend to converge on similar behavior, i.e. herding?

o Why is mass behavior prone to errors and fads?

- The human predisposition to imitate

o Given freedom, people usually imitate each other

o Evolutionary adaptation that has promoted survival use accumulated information

of generations before

- People make similar choices because:

o They face similar decision problems, i.e.

They have similar information,

They face similar action alternatives,

They face similar payoffs

- Exceptions:

o Opposing tastes can lead to opposing actions even if information is similar, i.e.

vegetarians and meat eaters

- How do individuals determine which alternative is better?

o Direct analysis of the alternatives costly and time-consuming

o Rely on the information of others less initial cost – observational/social learning

- Other possible causes of conformity may exist which do not require great similarity in

individuals’ decision problems but offer positive payoff externalities:

o driving on the right side, wear fashionable clothing, sanctions upon deviants

A MODEL FOR OBSERVATIONAL LEARNING

- Observable Actions versus Observable Signals

o Observable signals

Individuals can observe both the actions and signals of predecessors

Information signals enter the pool of public information one at a time as

individuals arrive

all past signals are publicly observed

information keeps accumulating

individuals with same payoffs eventually settle on the correct

choice

o Observable actions

Individuals can observe (only) the actions but not the signals of their

predecessors

Individuals often converge on the same wrong action, i.e. lower payoff


2

Idiosyncratic behavior error-prone choices of a few early individuals

determine the choices of all successors

- Order of Information, Noise, and Information Externalities

o Why is the outcome from observable-actions so different from the observable-

signals benchmark?

Because once a cascade starts, public information stops accumulating

private signals of subsequent individuals are being ignored

o Cascades start when information in the history of predecessors’ actions outweighs an

individual’s private signal

o The order in which signals arrive matters greatly in observable-actions scenario

results are path-dependent

HHLL all individuals adopt

LLHH all individuals reject

HLLH probability of ½ that Clarence begins a Up cascade

o Cascades are very likely after just 2 individuals! (observable-actions) approx. 75%

HH 0.2601 = 0.51 x 0.51

HL, coin toss 0.12495 = 0.51 x 0.49 x 0.5

LL 0.2401 = 0.49 x 0.49

LH, coin toss 0.12495 = 0.49 x 0.51 x 0.5

o In contrast, the probability of offsetting occurring is very small 0.004 after 8

players

o What is the probability of a cascade being correct?

Assuming V=1 0.513 = 0.38505/(0.38505 + 0.36505)

Up cascade 0.38505 = 0.2601 + 0.12495

Down cascade 0.36505 = 0.2401 + 0.12495

o In contrast, the probability of making the correct decision without observation at all

is 51 %, just 0.3% less than with action-observation!

- Fragility

o Cascades are fragile and shatter easily when exposed to shocks such as

The arrival of better informed individuals

The release of new public information

Shifts in the underlying value of adoption versus rejection

o Spock example – 2 signals

- Informativeness of Past Actions

o Summary statistics may be misleading!

Sales statistics may leave out the order in which individual purchased goods

o The number of predecessors one can observe is relevant!

In agriculture one often just looks at the immediate neighbors for reference

o Cascades are less likely the more action alternatives there are!

As the set of alternatives becomes larger and richer, cascades tend to take

longer to form and aggregate more information

- Differing Information Precision: Fashion Leaders

o Example of Aaron and Barbara:

Several neighbors decide between a Ford and a Toyota

Aaron, a car mechanic, buys first

His choice will be imitated because other people consider his expertise


3

Aaron becomes a “fashion leader”

o This I probably part of what underlies the success of product endorsements by

athletes about sports products / apparel / shoes / etc.

o To counteract this phenomenon judges might have to speak in inverse order of

seniority or rank (in military)

- Differing Preferences and Payoffs: To Each His Own

o Differing preferences, payoffs and types may cause learning to be confounded

because individuals do not know what to infer from the mix of preceding actions

o Example: software writer and Java platform

Signal realization

Heterogeneous preferences

Heterogeneous payoffs

Imperfect rationality

o A later individual can’t be sure why she has adopted early actions of early decision

makers are more noisy as indicators of their signals

- Changing Tastes or Payoffs

o Payoff changes may lead to behavior changes without an apparent reason

o Faddish nature

- Timing Choice and the Explosive Onset of Cascades

o The timing of sudden changes is usually unpredictable

o Higher precision individuals may trigger them as they have less to gain from waiting

to see the actions of informational inferiors

o Actions of other may be deferred until they see a trend

- Costly Information, Alternative Information Sources, and Network Externalities

o Cascades may form instantly if information acquisition has a cost

Barbara may not want to pay the cost of investigation to acquire knowledge

but would rather just follow Aaron’s lead

o Cascades may even form if additional sources of information are available

The payoff of alternative A is visible to all but alternative B’s payoff is

invisible but in the end it turns out superior cascading on A more likely

o Cascades provide informational externalities (about the value of adoption) but also

network externalities

Joining a network may benefit both the joiner and others who have already

joined

- Efficiency

o Discreet nature of decision causes inefficiencies

solution: trade in information

but: transaction costs

o third party (such as government) as a mitigation of cost

o other less centralized solution: communities and networks, internet

o Opposing effect: improved communication helps individuals learn about the actions

of others which might lead to a reduced incentive to gather information cascades

start sooner


4

APPLICATIONS

- Laboratory Experiments

o Provide cleanest tests of social learning theories

Controls minimize potentially confounding affects

- Business Strategy

o Imitation vs. differentiation hypothesis

Cascades theory suggests imitation

Differentiation suggests less competition and more profit

o Example: TV shows

ABC, NBC, and CBS imitate each other successfully

o Example: large firms as fashion leaders, small ones as followers

o Example: Opening of a new branch by a bank information based imitation (banks

observe each other and where rivals already have branches)

- Consumer Marketing

o Bestseller example

o Early adoption induced by low price may help start a positive cascade

o Underprices IPOs may lead to a positive cascade

- Crime and Enforcement

o The decision to commit a crime is influenced by the environment

News of kidnappings, assassinations, hijackings, and serial murders may lead

to a cascade

Neighborhood

o Broken windows theory (or other social disorder sign, graffiti etc.)

People observe signs of criminality cascade of rule breaking

- Politics

o Informational cascades in politics may be triggered by observing:

Public protests, demonstrations, riots, polls, voting results

o Historical example of East Germany

- Medical (Mal)practice

o Medical treatments are (historically) prone to informational cascades

Doctors cannot stay fully informed about relevant medical research advances

in all areas

Bleeding, hysterectomy, tonsillectomy

CONCLUDING REMARKS

- Herd behavior is fragile

o Cascades are triggered by a small amount of information

o These include mixtures of:

informational effects, sanctions against defectors, network externalities,

preference effects

o discreteness or boundedness of possible action choices are realistic assumptions

- Convergence arises locally or temporally upon a behavior, and can suddenly shift into

convergence on the opposite behavior

- Examples include: fixation on wrong technologies, stock market crashes, sharp shifts in

investment and unemployment, bank runs, election outcomes

learning from the behavior of others - conformity, fads, and informational cascades

Documents