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Social Transmission and Finance

Paper Session

Sunday, Jan. 3, 2021 10:00 AM - 12:00 PM (EST)

Hosted By: Association of Financial Economists & American Economic Association
  • Chair: Robert J. Shiller, Yale University

Moonshots, Investment Booms, and Selection Bias in the Transmission of Cultural Traits

David Hirshleifer
,
University of California-Irvine
Joshua B. Plotkin
,
University of Pennsylvania

Abstract

Biased information about the payoffs received by others can drive the evolution of innovation, risk-taking, and investment booms. We study this social phenomenon using a model based on two premises. The first is a tendency for large successes, and the actions that led to them, to be more visible and salient to onlookers than failures. For example, Google is more familiar than numerous failed startups. The second is selection neglect, the failure of observers to adjust for such biases. In our model, each firm in sequence chooses to adopt or to reject a project that has two possible payoffs, one positive and one negative. The probability of success is higher in the high state of the world than in the low state.
Adopting is on average profitable only in the high state. Each firm observes the payoff received by past adopters before making its decision, but there is a chance that any adopter's low-payoff outcome will be censored. Failure to account for this biased censoring causes later firms to become overly optimistic about the state of the world. We show how this induces irrational booms in adoption, which may later collapse, or which can even last forever in the low state. In particular, we find high rates of irrational long-run adoption for both moonshot projects and sure-bet projects, which feature either large but unlikely returns, or small likely returns. We interpret our results in the context of social evolution, where we treat adoption or rejection as a cultural trait transmitted between firms. A decomposition of trait change using the Price Equation reveals that the evolution of project adoption is driven by opposition between mutation pressure and evolutionary selection. This account provides a new explanation for investment booms, merger and IPO waves, and waves of

Biased Information Transmission in Investor Social Network: Evidence From Professional Traders

Jacqueline Ng Lane
,
Harvard University
Sonya S. Lim
,
DePaul University
Brian Uzzi
,
Northwestern University

Abstract

Using communication and trading records of professional traders, our study shows that investors are more likely to talk about their gains than losses, especially when they talk to their close contacts with strong ties. The message recipients appear to discount the information about their strong ties’ gains, and they earn higher returns on a stock when they receive a message from their strong tie who has a loss on the same stock. Our results suggest that investment information propagates in social network asymmetrically with respect to the type of the information and along connections with different tie strengths, yet message recipients appear to account for the asymmetry in their subsequent communications and trading decisions.

Active Trading and (Poor) Performance: The Social Transmission Channel

Laura Escobar Pradilla
,
World Bank
Alvaro Pedraza
,
World Bank

Abstract

Active investors often generate inferior returns. Social interactions might exacerbate this tendency, but the causal link between peer effects and active trading is difficult to identify empirically. This paper exploits the exogenous assignment of students to classrooms in a large-scale financial education initiative to evaluate the transmission of trading strategies among individual investors. The paper shows that students assigned to groups where classmates have more trading background, are more likely to start trading after completing the program. These social effects are stronger when peers have experienced favorable outcomes. The paper documents a negative consequence from social interactions: students that registered for courses where peer returns are large, generate lower trading profits than other investors. The evidence is consistent with social learning under biased information -- people share their most successful experiences, encouraging stock trading among uninformed investors. The results shed light on the role of selective communication in the transmission and adoption of ideas, and more importantly, in the behavior of people expose to biased information. The findings show that social learning can lead to misguided decisions when peer choices are not accurately observed by members of the social network.
Discussant(s)
Ilya Strebulaev
,
Stanford University
Harrison Hong
,
Columbia University
Jinfei Sheng
,
University of California-Irvine
JEL Classifications
  • G4 - Behavioral Finance
  • G4 - Behavioral Finance