Information Cascades : Replication and an Extension to Majority Rule and Conformity-Rewarding Institutions

The research reported here was originally motivated by the results of Lisa R. Anderson and Charles A. Holt (1997), who demonstrated the existence of cascades in sequences of individual decisions. In certain environments the decisions of individuals tended to reflect only the decisions of those who went before them and did not reflect the information they held privately. Our first question was whether the results they reported would replicate. Reflections on the problem led us to realize that the study of cascades is a branch of three strands of research. While these strands of research have similarities, they tend to reflect differences about the principles governing behavior. The first strand of research is the conformity or “herding” research which is focused primarily on models that might explain similarities in individual choices or interdependencies of preferences. Typically the phenomenon is called “herds,” “fads,” or “conformity,” which reflects a concern with “incorrect” or “wrong” cascades, despite the recognition that cascades can result from rational, Bayesian-Nash behavior. Even though the literature is less dramatic, it is easy to liken the behavior to lemmings in which each follows the one ahead over a cliff and falls to its death, all of which suggests that the behavior is viewed as being somewhat dysfunctional. Aspects of the second strand of research, the information aggregation literature, are frequently employed in the first strand. However, when viewed independently as an information aggregation issue, the topic of cascades is approached differently and aspects of market stability also become involved. 1 Cascade behavior is a Pareto improvement over behavior in which individuals base decisions only on their private information, since a cascade reflects an integration of more private information than any single individual possesses. However, all information is not integrated into a cascading system and the pattern of decisions themselves do not summarize and publicize a summary of private information as prices can do in markets. The phenomena involves an information externality or public good inefficiency problem fostered by the nature of the decision-making institutions and environment. The private information of those who make decisions, after the first person or two, is not made available to those who follow. Some of the early decision makers fail to contribute to the “public good” of pooled information. Thus, the information aggregation literature leads naturally to questions about the role of institutions and the efficiency of the system in both an allocation sense and in an information sense. The third strand of literature also leads to issues about institutions as well as the underlying reasons for the observed patterns of behavior. Cascades were observed many years ago by social psychologists, although they were given other names. Psychologists distinguished between conformity due to integration of private * Division of the Humanities and Social Sciences, M/C 228-77, California Institute of Technology, Pasadena, CA 91125. The financial support of the National Science Foundation and the Laboratory of Experimental Economics and Political Science is gratefully acknowledged. We are also deeply appreciative of the collaboration of David Winkler, who developed the software programs and helped extensively with the experiments. We benefited from conversations with Colin Camerer, David Grether, Richard McKelvey, Anthony Ziegelmeyer, and participants at the Economic Science Association meetings in October 1998, as well as comments from the anonymous referees. 1 Issues of market instability are closely related to the cascade phenomena by virtue of the interdependence of preferences and beliefs. See Gary S. Becker (1991), Edi Karni and Dan Levine (1994), and Plott and Jared Smith (1999). 2 For example, Abhijit V. Banerjee (1992) discusses “herd externalities,” and Sushil Bikhchandani et al. (1998) discuss the positive externality of revealing one’s private signal.