Thursday, October 16, 2008

irrational masses and panic selling

Another follow-up on the financial crisis.

Aside, from the decision-making process and loss aversion, there are other psychological reasons to explain the mass panic selling by investors.

Why do people follow the crowd and just sell their stocks?

One possible explanation is the pressure to conform. Following the crowd provides sense of security. ("if everyone is doing it, it must be the safe/logical/good thing to do")

Do not underestimate the pressure to conform

Social pressure exerted by others can seriously impact our own decisions. It can cause us to second-guess even the facts that we hold certain.

According to the Asch Paradigm or Asch conformity experiment, people who are put in a situation where there is a strong conformity among others (usually 3 or more) are more likely to conform the norm, even if the judgment is clearly false.

Essentially, the participants were asked to judge which of the 3 lines in the later card is the same length as the line in the first card shown.

What was found that if there was 3 or more people before who agreed unanimously that a certain wrong line is the correct answer (e.g. line B is correct), the participant will conform and give the wrong answer (line B, instead of the correct answer line C), 37% of the time. (The percentage may not seem a lot but considering that the correct answer is very clear-cut, the impact of social conformity is considerable).

For more information about the experiment and its critique


huimin said...

o.... i came across that conformity example in my sociology class!

Mara said...

^_^ yup. quite a few studies from psych cross over to sociology and other areas (eg econs)

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