Social Transmission Bias and Investor Behavior

Abstract

We offer a new social approach to investment decision making and asset prices. Investors discuss their strategies and convert others to their strategies with a probability that increases in investment returns. The conversion rate is shown to be convex in realized returns. Unconditionally, active strategies (e.g., high variance and skewness) dominate, although investors have no inherent preference for these characteristics. The model has strong predictions for how the adoption of active strategies depends on investors’ social networks. In contrast with nonsocial approaches, sociability, self-enhancing transmission, and other features of the communication process determine the popularity and pricing of active investment strategies.