Stock Markets are ideal places to track fads and information cascades because Stock Markets quantifiably merge emotion and information. From the first Tulip bubble in the Dutch Golden ages to the recent Internet stock market bubble, information cascades provide a framework when markets react in non-rational ways. Stock market corrections prior to the Great Depression were even known as panics, and both panics and bubbles are the result of many people chosing popular opinons contrary to prior individul information.

One recent example of this occured last month. As the Chinese bubble dipped, markets all over the world reacted with depressed markets because people presumed that if others believed that the Chinese dip would affect markets all over the globe. Stock markets from  Brazil to South Africa to Europe to America lost significant amount of value because people made panicked decisions based on emotion rather than reason. Indeed, despite the underlying problems behind the Stock Markets of the Roaring Twenties, it was the collapse ot a small bank in Austria that plunged the world in a global depression.

 No example of this was demonstrated as dramatically on Film than the classic 1980’s comedy starring Dan Akroyd and Eddie Murphy. Their aim was to use information cascades to build a fortune to retaliate against scheming caused by their bosses. While http://en.wikipedia.org/wiki/Trading_Places describes the climactic scene in more detail, the key points are as follows:

Assuming a piece of information was true, the two antagonists pay for shares at an inflated price assuming that the price will rise. Despite everyone’s preconceived guesses at what the fair price of Orange Juice may be, everyone buys and buys. Here exists a classic information cascade where despite preconceived notions, a mob mentality is created where people ignore these notions, initially follow the antagonist’ lead and soon everyone is chosing this deicison because everyone presumes that everyone else has better information.

Unfortnately, the information that was give to the antagonists was wrong. Oranges that year was expected to have a healthy crop, and thus prices are far lower than they had become. The protagonists used inside information and the principle of information cascades to make a lot of money as the information cascade had tipped in the other direction. Now the same mob intent on buying price inflated Oranges fighting to sell their shares as quick as possible, simply because other stock brokers were doing the same. The collective opinion on the value of these Oranges have then fluxuated wildly.

 In reality, Stock Markets have safeguards against panics and information cascades. If the price of Oranges fluctuates too wildly, the stock market stops trading. In essence, this is a mechanism designed to prevent information cascades. By preventing people from making quick decions, decisionmakers can then think rationally and independently of other people’s trading decisions to make rational decisions.