Effects of Financial Incentives on Herding in Simulated Financial Markets

Maria Andersson

Martin Hedesström

Tommy Gärling

University of Gothenburg,

Göteborg, Sweden

Social influence

Normative or informative influence?

The financial market

Which stock do you buy?

Background

Under what conditions do people follow others in financial markets?

A prerequisite is that others are in agreement, but how many others?

A majority can exert influence on a minority, but psychological experiments have shown that even minorities can exert influence on the majority.

Theoretical Background Social influence creates conflict between the source and the target of

influence. In conversion theory (Moscovici, 1985) two ways of solving these conflicts are proposed: Conforming to the majority’s view: Majority influence -

Comparison Accepting the minority’s view: Minority influence -

Validation

According to Moscovici (1985) there are qualitative differences between majority and minority influences, thus dual-process theory.

Moscovici’s concepts of comparison and validation have been associated with

- heuristic processing- systematic processing

(Erb, Bohner, Rank, & Einwiller, 2002; Martin, Hewstone, & Martin, 2007; Martin, Martin, Smith, & Hewstone, 2007; Tormala, DeSensi, & Petty, 2007)

Theory

Social comparison process

Validation process

Heuristic processing

Systematic processing

Conformity Conversion

Perception of a

Majority’s predictions

Perception of a

Minority’s predictions

Method overview - Task

Task:Predict “upmarket” or “downmarket”

Information in all conditions:- Before each trial, participants receive a signal.- The signal is sampled from one of two

distributions (upmarket or downmarket)- Signal range: 5 to 16

Method overview - Distributions

Upmarket mean = 12

Downmarket mean = 9

75%

75%

Method overview - Instructions

Probability of initial market state: upmarket/downmarket = 50%

Maximum one change

Change on any trial after the fifth (no change occurred)

Probability of market change = 50%

Method overview - Herd conditions Before each prediction, the predictions of three others

were shown to participants.

Always following the herd (majority or minority bonus) would lead to 50% correct.

Instructions:

All perform the same task based on randomly sampled numbers from the same distribution

Each participant is the last person in a sequence, thus results are not shown to other participants

Method overview - StimuliCase Signal Participant

AParticipant

BParticipant

C

1 >10 Up Up Down

2 >10 Up Down Up

3 >10 Down Up Up

4 >10 Up Down Down

5 >10 Down Up Down

6 >10 Down Down Up

7 >10 Up Up Down

8 >10 Up Down Up

9 ≤10 Down Up Up

10 >10 Up Down Down

11 ≤10 Down Up Down

12 ≤10 Down Down Up

Experiment 1 - DesignParticipants:

80 undergraduates. Design:

A 2 (bonus: no vs. individual) by 2 (herd: no herd vs. herd) by 2 (market state: up vs. down) by 60 (Trial) factorial design with trial as a repeated-measures factor.

Bonus conditions: Reward based on prediction accuracy Each correct prediction 4 SEK In total participants were paid 50-240 SEK, on average

170 SEK (~ € 18)No-Bonus conditions:

Fixed payment 170 SEK (~ € 18)

Experiment 1 - Hypothesis

Based on the idea that financially rewarding individual performance would trigger systematic processing (Maass et al., 1984; Martin et al., 2007; Martin et al., 2003), we hypothesize that participants in the bonus conditions will follow the signal more than participants in the no-bonus conditions and that the degree of herding thus will be lower in these conditions.

Experiment 1 - ResultsPercentage of following signal:

50

55

60

65

70

75

80

85

90

No bonus Bonus

Individual

Herd

Main effect of bonus:F(1,72) = 6.16, p = .015, 2

partial = .03

Main effect of herd: F(1,72) = 4.70, p = .033, ω2

partial = .02

Experiment 1 – ResultsIndex measure for herd conditions:

-0.3

-0.2-0.1

00.1

0.20.3

0.40.5

0.60.7

No bonus Bonus

Herd

Main effect of bonus:F(1,36) = 0.18, p = .677, ω2

partial =.00

Follow signal

Follow herd

Experiment 1 - Discussion

In line with the hypothesis, participants followed the signal more in the bonus conditions than in the no-bonus conditions. Thus, bonus seemed to have instigated systematic processing. They also follow the signal less when the herd is present.

Regarding following the herd, no significant effect of bonus was revealed. Thus, participants in the bonus conditions increased their attention to the signal, but the level of herding was constant.

Will the level of systematic processing change if participants are rewarded for following the majority/minority?

Experiment 2 - DesignParticipants:

40 undergraduates (+ 20 participants in Experiment 1)

Design: A 3 (bonus: majority vs. individual vs. minority) by 2 (market state: up vs. down) by 60 (Trial) factorial design with trial as a repeated-measures factor.

Bonus system: Reward based on prediction accuracy Each correct prediction 2 SEK If the correct prediction coincides with the herd’s

prediction 4 SEK In total participants were paid 50-240 SEK, on average 170

SEK ( € 18) This expected value of following the herd is always

lower than the expected value of following the signal.

Experiment 2 - Hypotheses

Rewarding herding with a minority is hypothesized to increase the level of systematic processing, which is supposed to make participants detect the low level of accuracy in the minority’s predictions. Therefore, participants in the minority-bonus condition are expected to be influenced by the signal to the same extent as participants in the individual-bonus condition. The level of herd behavior is expected to be higher in the majority-bonus condition than in the individual-bonus condition.

Experiment 2 - Results

-0.3

-0.1

0.1

0.3

0.5

0.7

Majoritybonus

Individualbonus

Minoritybonus

Herd

Main effect of bonus:F(2,54) = 4.46, p = .016, ω2partial

=.06

Only the majority-bonus condition differs from the other conditions.

Follow signal

Follow herd

Experiment 2 - Discussion

The results show that participants in the majority-bonus condition pay less attention to the signal and more attention to the herd than do participants in the minority-bonus condition. Thus, the majority bonus seem to have decreased systematic processing, whereas the minority bonus had no effect.

Conclusions A bonus made participants rely more on the signal, but had

no impact on following the herd.

There was a difference between individual/minority bonus and majority bonus, indicating that participants herd to a larger extent when they are rewarded for following the majority.

The results suggest that rewarding majority herding decreases systematic processing.

It is suggested that a majority influence can be enhanced but not decreased by different bonus systems.

Thank you!

Questions and comments?