Thursday, July 3, 2014

Stupidity of the crowds

Recent research from the Max Plank Institute for Psycholinguistics in the Netherlands show that Chimpanzees quickly copy arbitrary behavior of others in close proximity. The researcher noticed how a female chimp named Julie repeatedly put a blade of grass for no apparent reason in her ears and that behavior was copied rapidly by other chimps who observed it. This has implications for humans, who share most of the genetic make-up of chimps. Copying observed behavior of others may have had some evolutionary advantage for humans – at the very least it may have allowed them to experiment. It appears that such a notion is now built into the psyche of humans. This may have some negative consequences in the modern world.

For example, in the financial markets – there appears to be a tendency to follow arbitrary behavior of others, however stupid that could be. It has been established that in large markets, outcomes are generally efficient even though individual participants could be irrational and stupid. However, if copying is an in-built behavior pattern of the closest cousins of the chimps, then one could envision persistent excursions away from efficiency. Hedge funds, for example, may arbitrarily attempt a trade that could be replicated by many others – not because they understand it but because it is compelling to copy. The short term volatility in the market could be explained by such chimp-like behavior.

This behavior is equally apparent in real markets. For example, it is often observed that in large meetings within operating companies in which the participants are ambivalent as to the choices presented, a preemptive selection decision by one is quickly followed by many. In such experiments, the crowd could reach diametrically opposite decisions just because the first mover had preferences in one direction or another. Large companies are generally managed by chimp-like instincts exhibited by one and quickly adhered to by others.

It is ironic that large-brained animals – chimps and humans – may be more prone to group-think than others such as cats, who exhibit more individualistic preferences.