Economics - Wisdom of the Crowd | Assignment Desk

Economics- Wisdom of the
Crowd
Investigating financial markets where bubbles and crashes influence profits
and how following the crowd can be beneficial as well as foolish

INTRODUCTION
• Wisdom of crowd becomes assets or liability in the investment
world.
• It is not only true for bubble times but also for crash times.
• The current research is based on analyzing the financial market
where bubbles and crashes in stocks affect profit of investors
(Kozinets, Hemetsberger and Schau, 2008).
Cont….

• Research will identify weather wisdom of crowd is beneficial in
bubble and crash time or not.
• For attaining research objectives study will determine different
factors which may affect the wisdom of crowd.
• Impact on wisdom of crowd will directly affect the investor’s’
decision which will be describing in the following slides.

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Wisdom of Crowd
• Wisdom of crowd means collective opinion of a group of
entities about a particular subject and issue.
• “Many are smarter than few” and
• “Collective opinion is better than perception of a single
individual for a specific subject matter” (Marbach and et.al,
2012).
• Wisdom of crowd shapes business, economies, communities
and countries.
Cont….

• It plays important role in financial markets.
• Crowd word refers to the group of people who may be
associated with different disciplines, departments or
backgrounds.
• They may be an assembly of researchers, corporate, public or
experts in some specific field.
• Wisdom of crowd plays very significant role in financial market
(Lorenz and et.al, 2011).

Types of Crowd Wisdom
Crowd wisdom can be defined as a process which focuses on
collective opinion of a different groups rather than an individuals to
resolve a problem and get solution of a question (Kittur and Kraut,
2008).
There are three types of crowd wisdom:
1. Cognition
2. Coordination
3. Cooperation

1. Cognition
It is one of the fastest and effective crowd wisdom for analyzing a
single situation or a problem. Cluster of experts deliberately participate
in this process to give their opinions (Gaissmaier and Marewski,
2011). Opinions of crowd is based on their own thinking and
information processing so, political factors of the current market
cannot influence their perception about any subject.

2. Coordination
It focuses on the coordination of behavior between individuals of group in
which everyone is trying to do the same. It is a significant type of group
behavior which includes appropriate analysis of social behavior for
developing a strong opinion about a particular subject matter. Along with
this, it focuses on the maximum utilization of the rational decisions for
improving the collective opinion about problem or issue (Golub and
Jackson, 2010). This type of crowd wisdom works with individuals who
share common culture and makes a direct impact on common behavior
and opinions.

3. Cooperation
It a type of crowd wisdom in which group of people can form
networks of trust without a central system controlling their behavior
and their compliance (Chen, De, Hu and Hwang, 2014).

Bubble and Crashes in Financial Market

Bubble
• Market bubble is a significant increase in the total value of a
financial market.
• Bubble occurs if inventors increases their demand for a
particular stock beyond the actual performance of the underlying
company.
• Due to the market bubble price of particular stock raise (Ashby
and Yampolskiy, 2011).

Crashes
• Market crash is a substantial drop in the value of a market.
• At this time major investors think that market will give them massive
loss.
• So, in this situation investors try to sale their shares in less price for
minimizing their future loss (McFadden and Venker Weidenbenner,
2010).
• These types of panic selling decline the value of market and create a
situation of eventually market crashes and affects each and every
individual of economy.

Conditions for the Crowd to be Wise
Yampolskiy and El-Barkouky, 2011 has concluded that “for analyzing financial
market situations all crowd are not wise” (Yampolskiy and El-Barkouky, 2011).
There are some elements which can help in developing a wise crowd. These
criteria also help in making difference between wise and irrational crowds for
stock market bubbles and crashes.
These are as follows:
1. Diversity of opinions
2. Independence
3. Decentralization
4. Aggregation

Diversity of Opinions: For developing a wise crowd every individual of group
should have their own opinion and private information about the financial market
situation. Individuals can make their opinions by conducting interpretation of the
known facts and figures (Murr, 2011). So, diversity of knowledge and opinion of
every individual will help in predicting bubbles and crashes of financial market.
Independence: Individual’s opinion should not influence on the basis of the
opinions of the other members of the group. Independent opinion of individuals
help in making a wise crowd. Therefore, in the financial market if every individual
will have their own opinion about value of stock market than it will help in making
wisdom of crowd for financial bubbles and crashes (Mannes, 2009).

Decentralization: Nam, 2010 has concluded that “People are able to
concentrate and draw on local knowledge” (Nam, 2010). It helps in motivating
individuals to make important decisions on the basis of the local knowledge.
Aggregation: As per this element, collective opinion provides appropriate
solution of a problem as compare to the view of the smartest person (Zesch
and Gurevych, 2010).

Comparing the Crowd with an Individual
Expert
• Crowd wisdom always plays important role in attracting people towards the
financial market.
• Sometimes flaws in collective opinion may result in ineffective results as
compare to the opinion of individual experts (Kozinets, Hemetsberger and
Schau, 2008).
• Most of the organizations are widely trusted on knowledge and skills of
individuals and considered them as a quick and reliable source of
information.

• Literature review has reflected that level of knowledge of individuals is very
limited as compare to the group of expert. Because in a group every individual
may have different knowledge and skills which help in developing a strong
opinion for every situation (Marbach and et.al, 2012).
• Btu, on the other hand, if any individual who is expertise in a specific field than
their performance may affect in distinct situations and tasks.
• Results of literature has shown that sum of average opinions is more reliable
than choosing a single expert.
• But, still there are some factors which can influence the collective opinion of
crowd and leads towards the failure of crowd intelligence (McFadden and
Venker Weidenbenner, 2010).

Factors Resulting in Failure of Crowd
Intelligence
Number of elements can negatively affect the crowd intelligence.
These include:
1. Homogeneity
2. Centralization
3. Division
4. Limitation
5. Emotionality

Investigating of Financial Market Where
Bubbles and Crashes Influence Profits

• Sudden boom in market economy scare each and every one and the healing
process if very long and painful for investors.
• Therefore, at the time of market bubble investors are started to buy large
number of share at higher value because they expect raise in price
(Gaissmaier and Marewski, 2011).
• At the time of market bubble value of stock is predicted by investors very high
as compare to the actual performance of the core company.
• Therefore, economic bubble can increase the demand of the shares.
Impact of Bubbles
Cont….

• But at the time of economic boom individuals enjoy incredible job offers, hike
in salary and wages and increase number of investment during market
bubble. Overall, it has a positive influence towards the standard of living of
every individual (Nam, 2010).
• But, sometimes expectations of individuals may negatively affect if future
performance of particular shares becomes very low. It results the economic
downturn and reduction in purchasing power of every individual.
• So, every individual needs to focus on appropriate analysis of financial
markets and its fluctuations (Chen, De, Hu and Hwang, 2014).

Impact of Crashes
• Stock market crash is sudden and dramatic decline in price of stock market
which leads significant loss of investors.
• It increases the situation of panic selling of stocks.
• At this time investors think that price of shares may decline in future which
can increase the future loss of investors. And due to this rational they start
to sale their shares at very low price which increase their investment loss
(Ashby and Yampolskiy, 2011).
• Crashes lead financial and economic crisis, recession, depression.
• At the time of crash, investor sales their shares at any price so it has
negative impact on share price or stock value of underlying company
(Walter and Back, 2010).

Wisdom of Crowd can be Beneficial or
Foolish at the Time of Bubbles and Crashes

Yampolskiy and El-Barkouky, 2011 has concluded that “wisdom of crowds
becomes a liability in the investment world” (Yampolskiy and El-Barkouky,
2011). This statement if true not only for bubble and crashes times but also
during ordinary times.
• At the time of market bubbles wisdom of crowd is in the favor of high
investment.
• But, extensive research has reflected that wisdom of heading goes in
opposite direction. So, it’s a good sign to get out early and avoid running
further with the crowds.
• Economic position of 1929 and 2001 supports the above statements
because at that time every one was expecting market bubble but crash in
stock markets underscores the wisdom of crowd (Kittur and Kraut, 2008).

• Wisdom of crowd is generally based on the past performance but most of the
financial research has reflected that “Past performance is no guarantee of future
performance”.
• Social influence can degrade the collective opinion.
• Wisdom of crowd is beneficial or not is depend on the intelligence of crowd and
presence of attributes which help in developing a wise opinion of crowd (Zesch and
Gurevych, 2010).
• At the time of bubbles wisdom of crowd
• Wisdom of crowd is not beneficial for every situation because inaccurate collective
opinion about bubbles and crashes can creates a situation of eventually financial
losses of investors.
• In contrast, Delphi technique is one of the important model which helps in predicting
the future fluctuation in the financial market (Murr, 2011). If, wisdom of crowd in
based on this model than it helps investors in preventing future loss and getting
opportunity to increase their profit.

Conclusion
The current research has concluded wisdom of crowd plays very important role in
financial market because it can create an eventually bubbles and crashes.
Sometimes, collective opinion can decline the profits of investors and on the other
hand wisdom of crowd can reduce the total loss of individuals. Including this, study
has also found that, Diversity of opinions, Independence, Decentralization and
Aggregation are considered as important element which play significant role in
developing a wise crowd.
But on the other hand, according to literature Homogeneity, Centralization, Division,
Limitation and Emotionality are major factors which can harm the wisdom of crowd.
So, at the time of decision making investors needs to focus on all these factors
because these factors will help in taking appropriate decisions for investing amount
in shares.

References
• Ashby, L. H. and Yampolskiy, R. V., 2011. Genetic algorithm and Wisdom of Artificial Crowds algorithm applied to
Light up. In IEEE Intelligent Systems. pp. 27-32.
• Chen, H., De, P., Hu, Y. J. and Hwang, B. H., 2014. Wisdom of crowds: The value of stock opinions transmitted
through social media. Review of Financial Studies. 27(5). pp. 1367-1403.
• Gaissmaier, W. and Marewski, J. N., 2011. Forecasting elections with mere recognition from small, lousy samples: A
comparison of collective recognition, wisdom of crowds, and representative polls. Judgment and Decision Making.
6(1). pp. 73-88.
• Golub, B. and Jackson, M. O., 2010. Naive learning in social networks and the wisdom of crowds. American
Economic Journal: Microeconomics. Pp. 112-149.
• Kittur, A. and Kraut, R. E., 2008. Harnessing the wisdom of crowds in wikipedia: quality through coordination. In
Proceedings of the 2008 ACM conference on Computer supported cooperative work. pp. 37-46.
• Kozinets, R. V., Hemetsberger, A. and Schau, H. J., 2008. The wisdom of consumer crowds collective innovation in
the age of networked marketing. Journal of Macromarketing. 28(4). pp. 339-354.
• Leslie, M. B., 2010. The Wisdom of Crowds? Groupthink and Nonprofit Governance. Florida Law Review. (62). pp.
1179.
• Lorenz, J., and et.al., 2011. How social influence can undermine the wisdom of crowd effect. Proceedings of the
National Academy of Sciences. 108(22). pp. 9020-9025.
• Mannes, A. E., 2009. Are we wise about the wisdom of crowds? The use of group judgments in belief revision.
Management Science. 55(8). pp. 1267-1279.

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