Shareholders seen to be swayed by the buying pattern of other shareholders much less than has hitherto been assumed. This at least is the conclusion arrived at by economists of the Bank of England and the universities of Heidelberg and Bonn. Together with the corporate consultants McKinsey they scrutinised the share-buying behaviour of about 6,500 persons in an Internet experiment. They found no signs of 'herd instinct' during the experiment - on the contrary, some of the test subjects decided against buying those specific shares which had just been bought by so many other players. Psychologists, particularly, mistrusted those shares which they regarded as overvalued. This strategy benefited them enormously: on average they were markedly more successful in their speculation than physicists or mathematicians - or even economists.
On average the psychologists earned three times as much as economists and physicists in the stock exchange game. 'They tended to decide against buying shares precisely when a lot of other players had bought them,' Dr. Andreas Roider of the University of Bonn's Economics Department explains. Many discussions up to now have assumed the opposite: investors, it was thought, behave like lemmings. They always buy those shares which are most in demand at a particular time, thereby pushing the share prices too high (or too low). Hardly any explanation of the turbulences on the financial markets are without some reference to the marked predisposition to the herd instinct which allegedly investors show. Yet it might also be the case that each investor has decided in favour of buying independently of the behaviour of other investors - for example, because information has become available about a particular share which argues in favour of buying. Whether shareholders really are influenced by the 'herd instinct' is therefore hard to determine in practice.
An economic experiment under controlled conditions was meant to help clarify this issue. Together with corporate consultants McKinsey Professor Jörg Oechssler of the University of Heidelberg with his co-authors Dr. Andreas Roider and Dr. Matthias Drehmann of the Bank of England carried out a financial markets game via the Internet. In it just under 6,500 participants were able to deal in different stocks and shares. Prizes amounting to over 11,000 euros ensured that the game was taken seriously.
'The players were able to decide in favour of two fictitious shares A and B,' Dr. Roider explains. 'Only one share turned up a profit at the end of the game, the other being a dud.' Before making a decision to buy each participant was given a tip by their investment banker, e.g. 'Share A is a winner.' However, these tips were only true in two out of three cases - even investment bankers can make mistakes. As soon as a player had decided in favour of a specific share, the share rose in price. 'The players could now buy their shares consecutively,' Dr. Roider says. 'The first one was only able to rely on the investment banker's tip. The subsequent buyers, by contrast, were also able to see from the share index what shares their predecessors had chosen.
One million flies can't be wrong
In a situation like this even a 'bad' share can soar dramatically in price - simply because a lot of people choose it. Assuming the first two players get the tip to buy share A from their investment banker, even if player 3 then gets a tip to choose share B, that player may decide in favour of A - after all, his predecessors have apparently been tipped off to choose this share. Player 4, taking as a motto 'one million flies can't be wrong', will find it very difficult to buck the trend and choose share B. The result is that the herd instinct sends the value of share A up to dizzying - and ultimately irrational - heights.
In the experiment, however, those involved by no means followed blindly the behaviour of previous investors. - quite the contrary. As a rule the participants mainly allowed themselves to be influenced in their choice of share by their adviser's tip. In fact, many investors made a conscious decision to buck the trend, thereby contributing to a stabilisation of the share prices. 'This can of course be perfectly sensible if you think that the share is currently overpriced and that this is partly due to the irrational behaviour of earlier investors,' says Dr. Roider. The psychologists, particularly, seemed to ascribe share prices to these sorts of 'psychological' effects. Their intuition about the possibly irrational behaviour of other investors meant that they made bigger profits. By contrast, players who had studied Physics seemed to rely on the cool rationality of other participants - and thus fared worse.