Matteo Ploner at the University of Trento ran an experiment in which subjects were asked to choose between safe investments and riskier ones. He found that when people where told of others' choices, their own decisions resembled others' more closely than they did when they were not informed what others had done. In particular, people who had made cautious choices made riskier ones when they learned that others were more adventurous than them. "Social effects play a fundamental role in investment choices," concludes Mr Ploner.
This finding is significant because it captures only part of the range of possible peer effects. Because the experiment was conducted anonymously, it was not possible for subjects to imitate others because they wanted to fit in with their friends or follow the lead of people they trusted. It's likely, therefore, that in the 'real world' peer effects are even bigger. And, indeed, Hans Hvide at the University of Aberdeen has found just this: people's stock picks resemble those of their colleagues more closely than you'd expect.
These findings matter because they give us good scientific evidence - and better still, microfoundations - that asset prices can be excessively and irrationally volatile, as Nobel laureate Robert Shiller pointed out over 30 years ago. If we imitate others then over-priced assets can become more over-priced. When we see others buying tech stocks or credit risk, we might think "let's do what others are doing" rather than "this asset is over-valued". If we do, price rises will feed on themselves and bubbles will emerge.
However, it doesn't follow from this that prices are predictable - especially over shortish horizons such as less than a few years. This is because markets are complex processes; outcomes depend upon interactions between people. If one's selling easily begets others' buying, we'll have stable prices. If it begets others buying through peer effects, we'll get bubbles. But it's impossible to predict which type of interactions will dominate. This is why it's dangerous to ride bubbles; the correlated buying that produces them can become uncorrelated buying, thus giving us flat prices, or correlated selling and hence price falls.
Even if markets are irrational, it does not follow that it's easy to make money in them.
