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Are ethnically diverse markets better suited to avoid price bubbles?

Posted December 31, 2014

Ethnic homogeneity can increase the possibility of economic bubbles. This is the primary result of the new study recently published in the Proceedings of the National Academy of Sciences of the United States of America. “In homogenous markets, traders place undue confidence in the decisions of others. Less likely to scrutinize others’ decisions, traders are more likely to accept prices that deviate from true values,” American sociologist S.S. Levin at Columbia University and his colleagues state.

Image credit: Ken Teegardin via Flickr, CC BY-SA 2.0.

Image credit: Ken Teegardin via Flickr, CC BY-SA 2.0.

Financial bubbles arise when the discrepancy between real values of assets and their prices emerges. Although these collective errors are very damaging, mechanisms underlying their occurence are not well-known. Interdisciplinary team of researchers from American, British and German universities conjectured that this phenomenon can be heavily influenced by the ethnic structure of the stock market.

“In ethnically homogenous markets, we propose, traders place greater confidence in the actions of others. They are more likely to accept their coethnics’ decisions as reasonable, and therefore more likely to act alike,” the scholars think.

Meanwhile, intercultural environments are characterized by lower levels of trust. Consequently, individuals are inclined to monitor the behavior of others and do not assume that the actions of others are rational so easily. In such case, probability of price bubbles should decrease together with the likelihood of Herd Behavior.

“To test this, we constructed experimental markets in Southeast Asia and North America, where participants traded stocks to earn money. We randomly assigned participants to ethnically homogeneous or diverse markets,” the scientists explain. Striking market differences were discovered.

Experiments showed that traders working in ethnically diverse markets were able to predict real prices 58% better than individuals in ethnically homogeneous markets. These differences persisted in both experimental locations: North America and Southeast Asia.

“Ethnic diversity was valuable not necessarily because minority traders contributed unique information or skills, but their mere presence changed the tenor of decision making among all traders. Diversity benefited the market,” Levin and his associates claim.

Article: Sheen S. Levine et al., 2014, Ethnic diversity deflates price bubbles, 18524–18529  in Proceedings of the National Academy of Sciences of the United States of America, source link.

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