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Effects of financial incentives on herding in simulated financial markets

Conference paper
Authors Maria Andersson
Martin Hedesström
Tommy Gärling
Published in Paper presented at the International Association for Research in Economic Psychology (IAREP), Rome, Italy.
Publication year 2008
Published at Department of Psychology
Language en
Keywords Herding, financial markets, financial incentives, social influence processes
Subject categories Psychology

Abstract

Herding in financial markets refers to that investors influence each other when making investment decisions. In these experimental studies, herding leads to worse performance relative to relying on private information. Previous studies of herding have shown that majorities in general are more influential than minorities. The aim of this research was to investigate whether financial incentives impact herding with majorities and minorities under these conditions. In two experimental simulations of a financial market, participants predicted an “upmarket” or “downmarket” conditional on diagnostic information presented on each trial. In Experiment 1, participants in an individual condition only received private information, while participants in a group condition, in addition, received information about randomly generated predictions ostensibly made by three others. Economic incentives for accurate predictions were based on individual performance, and were hypothesized to counteract reliance on invalid information about the herd’s choices. As expected, performance was worse in the group condition than in the individual condition, implying that participants were influenced by the herd. In Experiment 2, the effects of financial incentives for making predictions similar to either the majority or the minority of the others were examined. We hypothesized that financially rewarding group performance may reinforce non-systematic processing, and hence enhance majority influence. Since minority influence is associated with systematic processing, we hypothesized that systematic processing in minority conditions may increase the influence of the private information, and thus improve performance. The results showed that participants followed the majority but not the minority. One explanation for the asymmetry in the effects of rewarding herding with a majority and a minority may be the notion that the tendency to conform overrides systematic processing in majority influence, whereas the reverse would be true in minority influence.

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