Coveting thy neighbor’s investment decisions

There’s a new, interesting paper that describes how we’re influenced by our social connections in how we invest.  The paper, called Information Diffusion Effects In Individual Investors’ Common Stock Purchases: Covet Thy Neighbors’ Investment Choices,” by Asst. Profs. Zoran Ivkovich and Scott Weisbenner at the University of Illinois at Urbana-Champaign. [Previous working paper available here.]

The findings are summarized in Mark Hulbert’s Neighborly Advice, for Good or Ill (NYT, Business Section, 7/15/07).

Hulbert writes: “The impulse to keep up with Joneses plays an enormous role in the behavior of consumers, whether they’re shopping for clothing or toothpaste, buying a home or deciding which school ought to be entrusted with their children…..It turns out that the investing arena is no different. When making changes in their portfolios, people pay a great deal of attention to what their neighbors are doing.”

The study analyzed 35,000 households’ stock portfolios (that had accounts with a large discount brokerage firm from 1991-1996).

Households from the same zip code were likely to herd in their investment behaviors (with the strongest herding for households more geographically proximate) and this herding was strongest in states that had the strongest social networks (using Robert Putnam‘s state-level data of social capital).   THe authors presume that in places with stronger social connections, individuals are more likely to learn what their friends and neighbors are doing, beit at the bowling alley, the PTA meeting, kids’ soccer, after church or at Rotary.

Hulbert notes, “Because the time period the professors analyzed ended in 1996, it is unclear what impact, if any, the explosive growth in investment chat rooms, and of the Internet generally, might have on the word-of-mouth effect. But in his book “Bowling Alone,” Professor Putnam argues that more traditional modes of social interaction are in many ways far more powerful than those conducted over the Internet. This suggests that the word-of-mouth effect is likely to still be playing a powerful role, Professor Weisbenner indicated in an e-mail message.”

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