Ethnic diversity deflates price bubbles

Sheen S. Levine*, Evan P. Apfelbaum, Mark Bernard, Valerie L. Bartelt, Edward J. Zajac, David Stark

*Corresponding author for this work

Research output: Contribution to journalArticlepeer-review

93 Scopus citations

Abstract

Markets are central to modern society, so their failures can be devastating. Here, we examine a prominent failure: price bubbles. Bubbles emerge when traders err collectively in pricing, causing misfit between market prices and the true values of assets. The causes of such collective errors remain elusive. We propose that bubbles are affected by ethnic homogeneity in the market and can be thwarted by diversity. In homogenous markets, traders place undue confidence in the decisions of others. Less likely to scrutinize others' decisions, traders are more likely to accept prices that deviate from true values. To test this, we constructed experimental markets in Southeast Asia and North America, where participants traded stocks to earn money. We randomly assigned participants to ethnically homogeneous or diverse markets. We find a marked difference: Across markets and locations, market prices fit true values 58% better in diverse markets. The effect is similar across sites, despite sizeable differences in culture and ethnic composition. Specifically, in homogenous markets, overpricing is higher as traders are more likely to accept speculative prices. Their pricing errors are more correlated than in diverse markets. In addition, when bubbles burst, homogenous markets crash more severely. The findings suggest that price bubbles arise not only from individual errors or financial conditions, but also from the social context of decision making. The evidence may inform public discussion on ethnic diversity: it may be beneficial not only for providing variety in perspectives and skills, but also because diversity facilitates friction that enhances deliberation and upends conformity.

Original languageEnglish (US)
Pages (from-to)18524-18529
Number of pages6
JournalProceedings of the National Academy of Sciences of the United States of America
Volume111
Issue number52
DOIs
StatePublished - Dec 30 2014

Keywords

  • Decision making
  • Diversity
  • Economics
  • Markets
  • Psychology
  • Sociology

ASJC Scopus subject areas

  • General

Fingerprint

Dive into the research topics of 'Ethnic diversity deflates price bubbles'. Together they form a unique fingerprint.

Cite this