Sociology of finance in the Proceedings of the National Academy of Sciences

What causes asset price bubbles? The paper below (just released) by Sheen Levine and David Stark looks into the issue in an original way. Findings: ethnic homogeneity promotes conformity and leads to misplacing; diversity disrupts conformity and leads to better information processing.

Here’s the longer summary:

In this paper from the Proceedings of the National Academy of Sciences, Sheen Levine and I (together with other co-authors) examine a prominent market failure: price bubbles. We propose that bubbles are affected by ethnic homogeneity in the market and can be thwarted by diversity. Using experimental markets in Southeast Asia and North America, we find that market prices fit true values 58% better in ethnically diverse markets. In homogenous markets, overpricing is higher and traders’ errors are more correlated than in diverse markets. The findings suggest that homogeneity promotes conformity. Price bubbles arise not only from individual errors or financial conditions, but also from the social context of decision making. Informing public discussion, our findings suggest that ethnic diversity disrupts conformity and leads to better information processing.

Congratulations, Sheen and David!