What Determines Word-of-Mouth Effects in Financial Markets?

Abstract

We study what determines the strength of word-of-mouth effects in financial markets. We identify a set of events that – for plausibly exogenous reasons – changes the information set for certain investors and causes such “treated investors” to trade. We infer the strength of word-of-mouth effects from the degree to which abnormal trading activity spills over from the treated investors to their neighbors and their neighbors’ neighbors. Our results suggest that word-of-mouth effects are strongest when financial markets are relatively calm, when investor sentiment is high, when there are few extraneous news events, when the information transmitted through word-of-mouth is positive and when the investors communicating with one another have similar backgrounds.

Keywords: Social Interaction, Investor Communication, Information Diffusion

JEL Classification: G11, G12, G14, G20