ACCORDING TO CNBC, more than one third of new investors are using social media to research investment advice. If such advice is independently produced by different contributors, it can benefit investors, because research shows that averaging independent judgments generally improves accuracy. This is known as ‘the wisdom-of-the-crowd effect.’
However, social media platforms disseminate information using engagement algorithms that are influenced by popularity bias — which means popular items are recommended more frequently than other items. And as such, they do not guarantee independent information aggregation. In one study, researchers found that financial social networks can serve as a platform for users to consume information that reinforces their pre-existing beliefs, resulting in ‘echo chambers’ that can undermine wisdom-of-the-crowd effects.
In a recent paper, we examined how information from three social media platforms — StockTwits, WallStreetBets and Seeking Alpha — impacts aggregate prices and price efficiency around earnings announcements. Earnings announcements provided an ideal setting for our analysis because conventional sources of information, such as media and analysts’ reports, are limited in the days leading up to these events. In contrast, investor social networks experience a surge in information production before earnings announcements.
If investors trade in line with social media’s wisdom, then stock prices leading up to earnings announcements should reflect future fundamentals such as earnings announcement surprises. However, we felt that if information is generated in echo chambers resulting in wishful thinking models, social networks could be detrimental to price efficiency.
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