Is the crowd wise?
The wisdom of the crowd in crowdfunding markets helps improve the decision making of the individuals, according to several studies. But is the crowd (really) wise?
NHH Norwegian School of Economics and the Argentum Center for Private Equity hosted the 2018 Bergen FinTech Conference this week.
FinTech has rapidly assumed center stage in the financial industry. The impact of informational technology is expected to radically restructure how finance is practiced.
Crowdfunding is a perfect example of the speed of change in finance.
Ali Mohammadi (Royal institute of Technology and Swedish house of Finance) opened the crowdfunding session with his lecture «How Wise Are Crowd? A Comparative Study of Crowd and Institutions in Peer-to-Business Online Lending Markets», based on a paper coauthored with Kourosh Shafi.
Funding small businesses used to be the exclusive domain of angel investors, venture capitalists, and banks. Crowd have only recently been recognized as an alternative source of financing, according to their paper. Therefore, the researchers wanted to study the functioning of the loan markets facilitated by online portals.
NEED INFORMED INDIVIDUALS
Despite preceding limitations faced by individuals, a recent stream of literature argues that resorting to the wisdom of the crowd in crowdfunding markets helps improve the decision making of the individuals. The wisdom of crowd claims that mathematical or statistical aggregates of the judgments of a group of individuals will be more accurate than those of the average individual by exploiting the benefit of error cancellation.
The necessary conditions for the formation of wisdom of crowd are that individuals in the crowd should be
- knowledgeable about the subject
- motivated to be accurate
Mohammadi and Shafi found that crowd underperform institutions in screening SMEs. The under-performance gap of crowd compared with institutions widens with risky and small loans, suggesting that crowd lack the expertise to assess the risks or the incentive to expend resources to perform due diligence.
Although their results show performance gap of the crowd relative to institutions, the magnitude of these effects are not so large to suggest madness of crowd:
«Rather, our results to some extent conform to prior findings that collective intelligence compare favourably to those from experts».
Social Media important
And what kind of information is important in securities crowdfunding?
This question was asked by researcher Vladimir I. Ivanov at U.S. Securities and Exchange Commission in his lecture «Soft and hard information and signal extraction in securities crowdfunding». This form of crowdfunding enables investors to fund startup companies and small businesses in return for equity.
Ivanov finds that hard information about issuer quality, information that is easily reduced to numbers, generally has at most a marginal role for the funding outcome, inconsistent with the hypothesis about hard information.
Soft information, as captured by social media and issuer communications, plays a significant role in the offering success. An issuer's ability to amass a significant social media following is viewed as a positive signal of issuer quality, potentially capturing a favorable outlook for market interest in the issuer's product or service and the recognition of the issuer's brand.
Bergen Fintech Conference continued throughout the day with sessions on bitcoin and blockchain. Take a look at the program!