Herding Behavior as a Network Externality

Abstract

Crowd-funding markets have recently emerged as a new avenue for entrepreneurs to raise funds. In these markets, any individual can pitch ideas and interested others can then invest in them. These markets provide investors with rich information on the investment decisions of prior others, thus they are rife with the potential for social influence. With this in mind, I examine a crowd-funded market for fashion, empirically evaluating some implications of Banerjee’s “simple model of herd behavior.” Specifically, I examine the implication that an increase in the number of observable decision makers within a marketplace should drive an increase in herding, because a greater number of inexperienced deciders will lower the average level of private knowledge in the market. I find evidence that supports this notion. Further, I identify a negative association between herding and the optimality of investor decision-making, supporting the characterization of herding as a negative network externality.

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