Investing can be a tricky and confusing business. For those who are new to it and thus gun-shy about choosing where to put their money, one appealing option is to mimic the investments of peers who seem to be doing well.
That might sound like it makes sense, but it’s often a dangerous strategy: When too many people jump on a hot investment trend, it can lead to huge losses if the market turns, or if the underlying asset proves to be not quite what people thought it was. Because this phenomenon can present problems not just to individuals but to entire markets, economists have given it a name—“investor contagion.”
Until now, most theories about how an investment idea spreads—and how detrimental this can be—were based on anecdotal examples of investment bandwagons. One of the most famous is when, in the 1600s, people in the Netherlands poured incredible amounts of money into the market for, of all things, tulips. During the market’s heyday, all manner of Dutch people joined in, including, in the words of some economists, “nobles, citizens, farmers, mechanics, seamen, footmen, maid-servants, even chimney-sweeps and old clotheswomen.” Then the market for the flowers crashed spectacularly.
But now, a new study from the National Bureau of Economic Research is taking a more rigorous approach by looking at the investments a group of people made, and then comparing them to the investments their neighbors made.