A situation where individuals follow the observed actions of others rather than their own private information, causing a sequence of identical decisions regardless of individual evidence.
Deeper Explanation
Information cascades explain how rational individuals produce collectively irrational market outcomes. If the first five investors buy a stock, a sixth investor may rationally conclude that those five buyers collectively know something he does not — and buy regardless of his own private negative assessment. Each subsequent buyer faces the same logic, and the cascade continues until some large-enough participant acts on private information and breaks the chain. Financial bubbles and crashes are extreme information cascades: the dotcom bubble was sustained by each new buyer concluding that the preceding buyers had a reason for their optimism. Contrarian investors profit from information cascades that have run past the point where the embedded consensus is correct.
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