An information cascade or informational cascade is a situation in which every subsequent actor, based on the observations of others, makes the same choice independent of his/her private signal. In an informational cascade, everyone is individually acting rationally. Still, even if all participants as a collective have overwhelming information in favor of the correct action, each and every participant may take the wrong action. A little bit of public information (or an unusual signal) can overturn a long-standing informational cascade. That is, even though a million people may have chosen one action, seemingly little information can induce the next million people to choose the opposite action. Fragility is an integral component of an informational cascade. There are two key conditions in an informational cascade model:
- Sequential decisions with subsequent actors observing decisions (not information) of previous actors.
- A limited action space (e.g. an adopt/reject decision). [1]
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Examples and fields of application
Suppose that there is a crossroad where everyone must choose whether to go left or right. If a person goes the wrong way he will be eaten by a grizzly bear, but if he goes the correct way he’ll end up in safety. Unfortunately, people have imperfect information, so they’ll only be right 2/3 of the time. If person 1 thinks left, he will go left. If person 2 thinks left he will also go left. However, if person 3 thinks that right is correct he will go left anyway. This is because the combined information of observing person 1 and person 2 go left is greater than person 3’s private information that right is correct. Even if every other person thinks that right is correct, they will all go left based on the actions of the first two individuals. In this scenario society will usually go the correct way, but at least one out of nine times everyone will go the wrong way.
Market cascades
Information cascades have become one of the topics of behavioral economics, as they are often seen in financial markets where they can feed speculation and create cumulative and excessive price moves, either for the whole market (market bubble...) or a specific asset, for example a stock that becomes overly popular among investors. Information cascades are usually considered by economists:
- as products of rational expectations at their start,
- as irrational herd behavior if they persist for too long, which signals that collective emotions come also into play to feed the cascade.
See also
External links
- Informational Cascades and Rational Herding: An Annotated Bibliography and Resource Reference
- A Bibliography of Information Cascades and Herd Effects
- Information Cascades in Magic
- Is Justin Timberlake a Product of Cumulative Advantage? Informational Cascade with another name, NYT article, may require login.
