What a vivid example of human irrationality:
An erroneous headline that flashed across trading screens Monday, saying United had filed for a second bankruptcy, sent the airline's stock plummeting.
United Airlines shares fell to about $3 from more than $12 in less than an hour before trading was halted, wiping more than $1 billion in value. Its shares closed at $10.92, down 11.2 percent.
By the end of the day, fingers were pointing in many directions to assign blame.
The episode was a reminder of how negative news, rumors and even outdated articles can travel at lightning speed, with some investors selling before pausing to check facts.
Oh, herd behavior. I've always enjoyed the example of herd behavior used by Robert Schiller, because it neatly illustrates how we rely on our social instincts when confronted with uncertainty. Imagine two restaurants that open next door to each other. The first hungry customer doesn't know which restaurant is better, so he flips a coin and hopes for the best. A little bit later, another customer arrives. He also doesn't know which restaurant is better, but he assumes that the restaurant with at least one customer must be better. When the third customer shows up, he sees two people in one restaurant and none in the other, so he also goes to the popular place. The cycle continues in this manner, and most customers end up choosing the popular restaurant, even though the other restaurant might serve better food. We clearly find comfort in numbers, especially when feeling anxious.
This is known as an information cascade, although what's striking is how little information is actually being analyzed when making a decision about where to eat, or whether or not to sell United stock. Instead of thinking for ourselves, we rely on the judgment of others, who are also relying on the judgment of others, and so on. "The popular notion that the level of [stock] market prices is the outcome of a sort of vote by all investors about the true value of the market is just plain wrong," Shiller writes. "Hardly anybody is really voting. Instead people are choosing not to, as they see it, waste their time and effort in exercising their judgment about the market."
- Log in to post comments
I don't get it. Weren't they responding to (false) information? And to their (correct) estimation of what the (false) information would do to the share price? That's mistaken in a sense, since the original information wasn't correct, but I don't see how it's irrational, or really counts as herd behaviour.
Schiller's analysis of restaurant customers assumes that each customer is trying to maximise his utility; i.e. they are trying to pick the best restaurant. However, it may be the case that they are trying to minimize risk. The second customer sees that the food at the first restaurant isn't bad enough to drive out the first customer, whereas the second restaurant has no customers and therefore offers no information about quality of its food. The second restaurant is riskier. The third customer sees the same thing, except there's more information about risk from the first restaurant; two customers instead of one. The more costomers who go into the first restaurant, the more information about risk is available from the first restaurant, while the second restaurant continues of offer no information about risk.
If customers are risk adverse, then their behavior in Schiller's example is perfectly rational.
Schiller is also overlooking the fact that some people don't want to go to a restaurant that is packed full of people!
And yes, I think Chris is onto something - people can't really be blamed for responding to the information they are given. If there hadn't been an erroneous headline, but only a rumour, then it would qualify more as herd behaviour. No?
Much of the fall in UAUA's stock yesterday can be attributed to programmed computer trading. Once a stock price falls below a certain price level within a certain timeframe, institutional computers are programmed to dump first and ask questions later. Like, should I NOW be BUYING this stock? The programmed trading brought the price down, but human discernment brought it back to almost $11. In the process a LOT of money was made and lost by those trading almost 60 million shares.
I agree that it doesn't count as "irrationality". The actors in these situations are merely using poor sources in a low information environment. Sure, they could go do research about each question, but by then they would surely lose the opportunity they have been presented with. They are still seeking what they believe to be best for them, using the only information that they have easy access to. Of course the decisions aren't objectively rational, but that isn't what's at question is it?
Maybe that explains McDonalds...seriously. Maybe its the "Billions and billions sold". There has to be an explanation other than their nasty food.