Informational cascade

In game theory, 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). [http://welch.econ.brown.edu/cascades/#79]

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.fact|date=October 2007

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.

Historical examples of cascades

* Small protests began in Leipzig, Germany in 1989 with just a handful of activists challenging the German Democratic Republic.cite book
last = Shirky
first = Clay
authorlink = Clay Shirky
title = Here Comes Everybody: The Power of Organizing Without Organizations
publisher = Penguin Press
location = New York
date = 2008
pages = 161-164
doi =
isbn = 1594201536 ] For almost a year, protesters met every Monday growing by a few people each time. By the time the government attempted to address it in September of 1989, it was too big to squash. In October, the number of protesters reached 100,000 and by the first Monday in November, over 400,0000 people marched the streets of Leipzig. Two days later the Berlin Wall was dismantled.

See also

* Groupthink
* Herd behaviour
* The Emperor's New Clothes

References

External links

* Sushil Bikhchandani, David Hirshleifer, and Ivo Welch. "A Theory of Fads, Fashion, Custom, and Cultural Change as Informational Cascades." "Journal of Political Economy", Vol. 100, No.5, pp. 992-1026, 1992.
* [http://www.info-cascades.info/ Informational Cascades and Rational Herding: An Annotated Bibliography and Resource Reference]
* [http://people.virginia.edu/~cah2k/cascy2k.htm A Bibliography of Information Cascades and Herd Effects]
* [http://www.starcitygames.com/php/news/article/12201.html Information Cascades in Magic]
* [http://www.nytimes.com/2007/04/15/magazine/15wwlnidealab.t.html?_r=3&ref=magazine&pagewanted=all&oref=slogin&oref=slogin&oref=slogin Is Justin Timberlake a Product of Cumulative Advantage?] Informational Cascade with another name, NYT article, may require login.

* [http://www.nytimes.com/2008/03/02/business/02view.html?_r=1&ref=business&pagewanted=all&oref=slogin How a Bubble Stayed Under the Radar] NYT article, may require login.