Herd Theory

[jducoeur]

As we watch the volatility continue to downright goofy levels, I find myself idly wondering whether economists have started formalizing the madness of crowds yet.

I mean, even if you believe that homo economicus is rational (which I don't really), it's very clear that people en masse are not. Herd mentality is a very powerful force, and tends to overwhelm rational behaviour. Indeed, it's not even 100% irrational: if you expect everyone *else* to be nuts, following along can be the most appropriate course.

Consider: I didn't get involved with the 1998 tech bubble at all, because it was so clearly ridiculous. Which meant that, while I didn't lose anything in the crash, I also didn't gain anything in the runup. (A few people *did* manage to profit quite nicely from the bubble.) And bank panics are very sensible, in a way: the more people pull their money out of a bank, the greater the chance that it will go under, which means that you had probably better pull your money out of the bank.

I'd bet that there are some fairly consistent curves that can be interpolated into the standard economic ones, though: even if you assume human behaviour is irrational, that doesn't mean it is inconsistent. There are almost certainly chaotic feedback effects -- it's a dynamic system, and those are always complicated -- and it's very hard to predict on the small scale, but I'd bet that it is susceptible to smart modeling that can at least make some statistical sense out of the madness...

Comments

Bank panic

[dlevey.livejournal.com]

Does this hold anymore - at least for FDIC/FSLIC-insured banks?

[qarylla.livejournal.com]

Unrelated in a way to the current economic forces, you might find Bellwether by Connie Willis an interesting read. It is about herd mentality in both sheep and people. It's a non-economic look at what you're talking about right here.

[serakit.livejournal.com]

So what starts it? If herd mentality is based on what everyone else is doing, there has to be, somewhere, someone who decided that what the herd is doing was logical, because someone had to do it before it was a herd mentality to create the herd mentality.

If that even made sense...

[meiczyslaw.livejournal.com]

I ran across an article about such a study. Unfortunately, I didn't think to dump it onto my "sparky" tag on my journal because I'd posted something similar on September 30th.

But there are smart people who've figured out that traditional economic theory has a flaw, in that people are expected to act rationally. The new field includes trying to predict irrational behavior.

[dryfoo.livejournal.com]

Fella named Dan Ariely (I think that's the last name) a/k/a dandan@mit.edu -- formerly at MIT now at Duke -- wrote a well-received book about irrationality in economic actors. It might have some of what you're looking for.

Regarding predicting the market: since it really is chaotic, those characteristic shapes you're looking for will be there, but they're going to appear at every scale, so you won't know if you're seeing the peak of the day, the week, the year, or just the previous 5 minutes.