Ethnic diversity can deflate stock market bubbles, study finds

December 10, 2014, University of Texas at Dallas
stock market

Stock market bubbles have led to economic catastrophes from the Great Depression through the dot-com boom of the 1990s and up to the recent housing financial crisis. Although these episodes cause widespread financial havoc, the reasons behind economic bubbles remain unclear.

A new study proposes a cause: Bubbles happen when people mindlessly trust the behavior of others, particularly when surrounded by ethnic peers. In an article in the Proceedings of the National Academy of Sciences, a team of researchers found that markets of ethnically diverse traders are much less likely to suffer . These findings could have a lasting impact on economics—and .

"Ethnic diversity can bring a variety of perspectives, but it is also valuable because it changes how people think, feel and behave," said Dr. Sheen Levine, an assistant professor at The University of Texas at Dallas who conducted the research while on the faculty of Columbia University.

To examine how ethnic diversity affects price bubbles, Levine and his collaborators constructed experimental markets in Southeast Asia and North America. It was a laboratory for bubbles: "We could pinpoint the true value of a stock, and compare these true values with market prices," Levine said. "So we could identify bubbles as soon as they appeared and measure their exact magnitude."

The researchers randomly assigned participants, all versed in finance, to ethnically homogeneous or diverse markets, letting them trade stocks to earn cash. There were no initial differences between traders in homogenous and diverse markets. But when trading began, a striking difference between the markets emerged.

Homogenous markets were much more likely to bubble. In them, overpricing was higher as traders were more likely to accept speculative prices. Their pricing errors were more correlated than in diverse markets. And when bubbles burst, homogenous markets crashed more severely.

"Bubbles have been long ascribed to herd behavior, but hard evidence has been scarce until now," Levine said. Across markets and locations, market prices fit true values 58 percent better in diverse markets.

What is the practical significance of the findings? Levine points to a recent study by the Graduate Center of the City University of New York, which found that more than half of Wall Street's workforce was made up of white men who earned more than twice as much as women and minorities. In the financial center of London, there may be even less diversity, suggest data from recruiting firm Astbury Marsden, Levine said.

"Our findings are another compelling reason to diversify markets, teams, boards and organizations," he said.

Explore further: Ethnic diversity reduces risk of market bubbles

More information: "Ethnic diversity deflates price bubbles." PNAS 2014 ; published ahead of print November 17, 2014, DOI: 10.1073/pnas.1407301111

Related Stories

Ethnic diversity reduces risk of market bubbles

November 18, 2014

If they consider it at all, investors likely regard ethnic diversity as a matter of social policy. But new research by an MIT Sloan professor suggests a much more practical reason to consider diversity: compared to markets ...

When brain says buy, you may not know why

July 11, 2014

Billions of neurons fire in the brains of stock market traders as they decide whether to buy or sell shares in a matter of seconds. Some of these brain waves produce rational calculations about how best to make a profit, ...

Blueprint of a trend: How does a financial bubble burst?

May 2, 2011

A joint study by academics in Switzerland, Germany and at Boston University sheds new light on the formation of financial bubbles and crashes. Wild fluctuations in stock prices caused by bubbles bursting have had a dramatic ...

Recommended for you

Earth's deep mantle flows dynamically

March 25, 2019

As ancient ocean floors plunge over 1,000 km into the Earth's deep interior, they cause hot rock in the lower mantle to flow much more dynamically than previously thought, finds a new UCL-led study.

Scientists solve mystery shrouding oldest animal fossils

March 25, 2019

Scientists from The Australian National University (ANU) have discovered that 558 million-year-old Dickinsonia fossils do not reveal all of the features of the earliest known animals, which potentially had mouths and guts.

7 comments

Adjust slider to filter visible comments by rank

Display comments: newest first

RadiantThoughts
1 / 5 (3) Dec 10, 2014
no, no, no just no. id rather be broke poor in my own country than flooded to demographic destruction.
kochevnik
5 / 5 (1) Dec 10, 2014
Fiat garbage currency (which isn't even money) causes bubbles. Rulers prefer diversity because the population is already divided, thus already conquered
ryggesogn2
1 / 5 (2) Dec 10, 2014
Truly free markets, markets with no federal reserve and Regulatory State trying to kill this or that industry, deflate bubbles.
mc6809e
not rated yet Dec 10, 2014
Distrust in others might be good at preventing bubbles, but is distrust good for a community? Does distrust promote volunteerism? Does distrust create an atmosphere of safety?
ryggesogn2
1 / 5 (2) Dec 10, 2014
" Bubbles happen when people mindlessly trust the behavior of others,"
People can only learn from their mistakes.
distrust good for a community? Does distrust promote volunteerism? Does distrust create an atmosphere of safety?


Distrust in what?
I don't trust certain cultures, based upon experience.
In particular, individuals in certain cultures are call perfect strangers 'my friend'. They must earn my trust.
kochevnik
3 / 5 (2) Dec 10, 2014
@ryggie Distrust in what?
I don't trust certain cultures, based upon experience.
In particular, individuals in certain cultures are call perfect strangers 'my friend'. They must earn my trust.
Yes many cultures prefer enclaves over integration. Russians naturally integrate, but California is full of people speaking Vietnamese or Korean with their own markets and their own car dealers and their own way of driving, which endlessly causes accidents. Indians bring their caste culture and 40 of their associates stuffed into tiny little cubicles then peddle their slave boat to Silicon Valley. Africans in UK effectively have taken the streets for themselves stealing and looting while the police look bewildered and Arabs refurbish all the real estate to Islamic standard banning all fashionable clothing stores and pubs. Mexicans buy and hold homes for century hence pay near zero property tax back to community while residents must compensate. African Americans avoid Africans
Egleton
not rated yet Dec 11, 2014
We Dun it Again!

We certainly are special. Is there Nothing that the white Anglo-Saxon male is not responsible for?

Please sign in to add a comment. Registration is free, and takes less than a minute. Read more

Click here to reset your password.
Sign in to get notified via email when new comments are made.