How Wall Street got trampled by the herd: A behavioural science perspective on GameStop

It is not at all surprising to behavioural economists that herd behaviour has translated into market exuberance – again. But what is surprising may be the social psychology at play, further demonstrating the great cultural divisions that exist in Western democracies today.

Briefly, a recap. You likely will have heard of how a bunch of millennial Redditors moonlighting as traders managed to bring down hedge fund Melvin Capital and increase the share price of an underappreciated company called GameStop by an incredible 162 percent, to USD325 a share at its peak. The David versus Goliath tug of war has revealed a rupture amongst economists, and therefore, by the industry and government responses that may follow.

To understand the behavioural perspective, we must first look at the fundamentals underpinning economics: rational behaviour. Economists from the traditional school may have likely been by surprised: “But it’s an ailing, almost irrelevant video game retailer. What future can they have? The fundamentals remain – the share price should fall”. Political economists may also be surprised: “How did disparate beneficiaries with imperfect information band together to disrupt the spoils of boomer billionaires who fund lobby groups that serve to continue to serve the rich and status quo in a death spiral towards the eventual failure of nation states?”.

Behavioural economics can explain seemingly irrational events and behaviours, amongst individuals, and in the aggregate behaviour of traders in a marketplace. The first and most well-known behavioural economics principle operating in the GameStop case is herd behaviour. This is where decisions by individuals are made in a social context – i.e. investors are mimicking the investment decisions of others around them. In behavioural finance, this will often lead to situations where there are periods of selling or buying happening in the usual absence of any change to fundamentals, such as the asset holdings of a company or profit announcements. But the last week is a timely reminder that financial market bubbles are not anomalies, but a regular occurrence. As we discuss, mass, instantaneous communication and collective action can lead them to happen with increasing frequency and amplitude- and industry and regulators will have to add behavioural economic analysis to complement toolkits for appropriate business and policy responses.

In addition to herd behaviour, there may be two other behavioural factors at play.

Where social identification amongst group members occurs, ingroup favouritism and social incentives to perform group-endorsed behaviours may follow– such as defending the share price of GameStop. Platforms such as Facebook groups and subreddits are proliferating daily, acting as lightning rods for interests so marginal (think QAnon) that even the most niche of interest holders will find likeminded friends. In the case of GameStop, the marshalling point was an interest in making coin on a shorted meme stock that Melvin Capital had bet against (NB meme stocks are often so-called for their ability to “go viral” amongst the 4 million-odd users of WallStreetBets). Social identification is likely to have increased as media attention grew, and the perception of an “us versus them” tussle, between the Redditors and hedge fund investors.

The second is that online platforms have also removed the traditional barriers, or frictions to collective action, enabling collectivism on a grand scale at very little cost or effort to those participating. Frictions are the small, ostensibly irrelevant details that require additional effort to complete a task, the perceived “hassle factor” of, for example, consolidating one’s superannuation prevents a large number of people from ever completing the task of doing so, despite our best intentions and knowledge that it will lower costs and optimise our retirement income. The Robinhood app removes this hassle factor to trading; and consequently minimises the time, cost and effort of actions required of the WallStreetBets ingroup. If the endorsed ingroup behaviour is to buy GameStop stocks, performing this task has never been easier.

Although we have now seen the GameStop bubble burst (share prices have tumbled from their January peak, though we note they are higher than prior to the Reddit rally) the question remains of how industry and government responds to these new dynamics.

Robinhood, the platform that suspended trading in the affected shares is now subject to calls for investigation called for by several US government officials, from both sides of the political spectrum. To do this investigation justice will require a more holistic view, including through a behavioural lens, of what happened and why- as an essential guide as to what should happen next.

Beyond any investigation, there is more at stake. Media and social commentators are beginning to conflate social identity with social competition, where minorities band together to disrupt the status quo. Rather than an isolated incident of retail traders versus billionaire investors this is being interpreted as another fissure in the ravaged socio-political landscape of the US: The growing divide between the “haves”, once confident in the status quo, and the “have-nots”. who are only just discovering their collective power as an intoxicating antidote to decades of low wages growth and in some countries, poor employment prospects and a future that looks relatively less prosperous than those of previous generations.

All economists, behavioural or otherwise, can only conclude that the games are only just beginning.

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