Effects of Financial Incentives on Herding in Simulated Financial Markets Maria Andersson Martin Hedesström Tommy Gärling University of Gothenburg, Göteborg, Sweden

Social influence Normative or informative influence?

The financial market Which stock do you buy?

Background Under what conditions do people follow others in financial markets? A prerequisite is that others are in agreement, but how many others? A majority can exert influence on a minority, but psychological experiments have shown that even minorities can exert influence on the majority.

Theoretical Background Social influence creates conflict between the source and the target of influence. In conversion theory (Moscovici, 1985) two ways of solving these conflicts are proposed:  Conforming to the majority’s view: Majority influence -Comparison  Accepting the minority’s view: Minority influence -Validation According to Moscovici (1985) there are qualitative differences between majority and minority influences, thus dual-process theory. Moscovici’s concepts of comparison and validation have been associated with - heuristic processing - systematic processing (Erb, Bohner, Rank, & Einwiller, 2002; Martin, Hewstone, & Martin, 2007; Martin, Martin, Smith, & Hewstone, 2007; Tormala, DeSensi, & Petty, 2007)

Theory Social comparison processValidation process Heuristic processingSystematic processing ConformityConversion Perception of a Majority’s predictions Perception of a Minority’s predictions

Method overview - Task Task: Predict “upmarket” or “downmarket” Information in all conditions: - Before each trial, participants receive a signal. - The signal is sampled from one of two distributions (upmarket or downmarket) - Signal range: 5 to 16

Method overview - Distributions Upmarket mean = 12 Downmarket mean = 9 75%

Method overview - Instructions  Probability of initial market state: upmarket/downmarket = 50%  Maximum one change  Change on any trial after the fifth (no change occurred)  Probability of market change = 50%

Method overview - Herd conditions Before each prediction, the predictions of three others were shown to participants. Always following the herd (majority or minority bonus) would lead to 50% correct. Instructions:  All perform the same task based on randomly sampled numbers from the same distribution  Each participant is the last person in a sequence, thus results are not shown to other participants

Method overview - Stimuli CaseSignalParticipant AParticipant BParticipant C 1>10Up Down 2>10UpDownUp 3>10DownUp 4>10UpDown 5>10DownUpDown 6>10Down Up 7>10Up Down 8>10UpDownUp 9≤10DownUp 10>10UpDown 11≤10DownUpDown 12≤10Down Up

Experiment 1 - Design Participants: 80 undergraduates. Design: A 2 (bonus: no vs. individual) by 2 (herd: no herd vs. herd) by 2 (market state: up vs. down) by 60 (Trial) factorial design with trial as a repeated-measures factor. Bonus conditions:  Reward based on prediction accuracy  Each correct prediction  4 SEK  In total participants were paid SEK, on average 170 SEK (~ € 18) No-Bonus conditions:  Fixed payment 170 SEK (~ € 18)

Experiment 1 - Hypothesis Based on the idea that financially rewarding individual performance would trigger systematic processing (Maass et al., 1984; Martin et al., 2007; Martin et al., 2003), we hypothesize that participants in the bonus conditions will follow the signal more than participants in the no-bonus conditions and that the degree of herding thus will be lower in these conditions.

Experiment 1 - Results Percentage of following signal: Main effect of bonus:F(1,72) = 6.16, p =.015,  2 partial =.03 Main effect of herd:F(1,72) = 4.70, p =.033, ω 2 partial =.02

Experiment 1 – Results Index measure for herd conditions: Main effect of bonus:F(1,36) = 0.18, p =.677, ω 2 partial =.00 Follow signal Follow herd

Experiment 1 - Discussion  In line with the hypothesis, participants followed the signal more in the bonus conditions than in the no-bonus conditions. Thus, bonus seemed to have instigated systematic processing. They also follow the signal less when the herd is present.  Regarding following the herd, no significant effect of bonus was revealed. Thus, participants in the bonus conditions increased their attention to the signal, but the level of herding was constant.  Will the level of systematic processing change if participants are rewarded for following the majority/minority?

Experiment 2 - Design Participants: 40 undergraduates (+ 20 participants in Experiment 1) Design: A 3 (bonus: majority vs. individual vs. minority) by 2 (market state: up vs. down) by 60 (Trial) factorial design with trial as a repeated-measures factor. Bonus system:  Reward based on prediction accuracy  Each correct prediction  2 SEK  If the correct prediction coincides with the herd’s prediction  4 SEK  In total participants were paid SEK, on average 170 SEK (  € 18)  This expected value of following the herd is always lower than the expected value of following the signal.

Experiment 2 - Hypotheses Rewarding herding with a minority is hypothesized to increase the level of systematic processing, which is supposed to make participants detect the low level of accuracy in the minority’s predictions. Therefore, participants in the minority-bonus condition are expected to be influenced by the signal to the same extent as participants in the individual-bonus condition. The level of herd behavior is expected to be higher in the majority-bonus condition than in the individual-bonus condition.

Experiment 2 - Results Main effect of bonus:F(2,54) = 4.46, p =.016, ω 2 partial =.06 Only the majority-bonus condition differs from the other conditions. Follow signal Follow herd

Experiment 2 - Discussion The results show that participants in the majority-bonus condition pay less attention to the signal and more attention to the herd than do participants in the minority-bonus condition. Thus, the majority bonus seem to have decreased systematic processing, whereas the minority bonus had no effect.

Conclusions A bonus made participants rely more on the signal, but had no impact on following the herd. There was a difference between individual/minority bonus and majority bonus, indicating that participants herd to a larger extent when they are rewarded for following the majority. The results suggest that rewarding majority herding decreases systematic processing. It is suggested that a majority influence can be enhanced but not decreased by different bonus systems.

Thank you! Questions and comments?