Information Cascades
October 14, 2008 – 11:14 pm by BHCass R. Sunstein had an interesting piece in The New Republic this weekend looking at the role of information in our current crisis. An excerpt (tnr):
By historical standards, home prices jumped spectacularly from 1997 to 2004. In that period, many people thought, and said, that it is in the nature of home prices to increase over time, and people’s behavior tracked their belief. But the belief was demonstrably false. From 1960 to 1997, home prices were relatively stable, until the unprecedented boom that began in 1997.
As behavioral economist Robert Shiller has shown, the best explanation of the real estate bubble greatly overlaps with the best explanation of the stock market bubble of the late 1990s: In both cases, people were greatly influenced by a process of social contagion that amounted to an informational cascade. This belief produced wildly unrealistic projections, with palpable consequences for home purchases and mortgage choices.
Sunstein gives a good introduction to the idea and illustrates it with a simple example. When we look back at what has happened the role of information will be listed as a primary driver of the crisis. Of course, it’s not clear how knowing all of this helps us get out of the crisis at this moment, but perhaps some deep breaths and a more rational reassessment of our current conditions will help.
