Investor News: Peer pressure inflates stock bubbles

November 7, 2007

The herd mentality is alive and well when it comes to investing in high-risk, high-potential stocks. Researchers found that what investors fear most is not the chance they'll lose money with their investments, but the risk that they'll do worse than their peers.

The herd mentality is alive and well when it comes to investing in high-risk, high-potential stocks. Researchers from the Stanford Graduate School of Business and Duke University found that what investors fear most is not the chance they'll lose money with their investments, but the risk that they'll do worse than their peers. "Investors fear being poor when everyone around them is rich," says Peter DeMarzo, one of the authors of the study published in the Journal of Financial Economics. When the neighbors are touting the next "sure thing," others follow, afraid they'll miss out on the riches to come.

It's because of this internal pressure that investors tend to gather around high-tech issues with the potential to bring huge returns, which explains the bubble phenomenon. But the authors say nearly 90 percent of these stocks fizzle out, as the dot.com debacle surely taught us. It's small consolation that "if everyone loses their money together, it's perceived as not as bad as if just you alone lose," says DeMarzo. For the complete study, visit faculty.fuqua.duke.edu/~rkaniel/webpage/papers/bubbletechnology.pdf.