Mass movements

FELIX SALMON explains the mighty rolling breaker (ah, to be a surfer on that wave) that is Netflix's share value over the past 18 months in a fashion simultaneously pithy and horrifyingly empty.

Netflix...was for a very long time a steamroller which would just flatten anybody who tried to short it. And so the shorts went away, bruised, bloodied, and beaten. Without short interest, there was almost nothing keeping Netflix stock in the realm of sanity... But then the stock started falling, and all those dynamics were reversed. In a normal company with some kind of short interest, a falling stock price is met with shorts taking profits and supporting the price. In this case, the shorts were few and far between, and they too were enjoying the momentum trade. They weren’t covering.

Indeed, short interest started going up, rather than down: all the momentum traders who were happy making money on the way up were equally happy to try to make even more money on the way down.

Essentially, the stock price became a freelance entity divorced from any semblance of corporate fundamentals. For such an entity, when the price is rising, more people buy, driving the price up. When the price is falling, more people sell, driving the price down. There is no equilibrium and no underlying value. Question: How many other stocks exhibit similar properties?

Relatedly (at least as seen from my paranoid brain), Chris Ellis and John Fender, economics professors from the University of Oregon and the University of Birmingham, respectively, have a brief summary today of their new paper in the Economic Journal, titled "Information Cascades and Revolutionary Regime Transitions".

[W]e use the idea of information cascades to develop a theory of political regime change brought about by the occurrence or threat of revolution.

An information cascade, speaking loosely, is where people make decisions on the basis of their observations of other peoples’ actions. According to the analysis in our study, workers decide whether or not to rebel by observing other workers’ behaviour, as well as by observing any ‘signals’ that they may receive about the state of the regime. So if some people rebel, others may follow, thinking that their rebellion may be a sign of the regime’s weakness. If enough of them rebel, there is a successful revolution and the rulers are overthrown.

...The model can explain why revolutions are often a considerable surprise to virtually everyone, participants and spectators alike—something that is clearly applicable to the currently unfolding events of the ‘Arab Spring’, where there are information cascades both within and between countries.

The authors add: "We have not mentioned the role of such cascades in the financial crisis, but undoubtedly such cascades were important for many of the events of the crisis, and more generally may well be important for the stock market."

Today, the 17 leaders of the euro-zone countries are meeting to try to prevent a cascade imparting negative information about the value of government debt in southern European economies. While we wait to see whether or not leaders can come to a comprehensive agreement, European stock markets are holding essentially flat, as is the spread on yields between Italian and German ten-year bonds. If leaders fail to come up with an agreement, we're likely to see those spreads jump again as they did in August. Traders will test the waters to see whether they can break the European Central Bank's half-hearted commitment to keeping spreads low by repurchasing bonds in the secondary market. If some traders successfully short Italian debt, others will follow their example, and prices will plummet.

Where else are masses of people "making decisions on the basis of their observations of other people's actions"? Six weeks ago, people started camping out to protest various inequities of economics and governance in New York City. That led other people to camp out in Boston...

...and London...

...and Amsterdam...

...and about a hundred other cities around the world.

Does this add up to anything? I'm not really sure. Once you boil the fancy term "information cascade" down to "people imitating each others' behaviour", it doesn't look like much of an insight. Still, it does seem like changes in information technology are leading to more rapid coalescence of these types of herd behaviour, and that this is leading to a more unified global society in which there are more positive feedback loops, fewer natural checks on self-exacerbating mass phenomena, and a lower probability that things in any given sphere will tend towards an equilibrium rather than cycling wildly between various creative and/or disastrous extremes.