The Rise of Reddit: How Social Media Affects Belief Formation and Price Discovery

Abstract

Using submission level data from the social media platform Reddit, we rely on the theoretical framework of Pedersen (2022) to examine how social media affects belief formation, price discovery, and trading dynamics. Consistent with the predictions on network belief spillover, we find that the opinions of hardheaded investors (rational or fanatic) significantly predict future opinions of naïve investors, especially when these investors have larger influence. For return predictions, social media tones positively and significantly predict future returns, and more so when agents’ influence is higher. Finally, for trading dynamics, higher agent tones in networks with higher agent influence increase retail flows and deter shorting flows. Short sellers’ consideration of agent influence in deciding to ride or burst bubbles enhances their abilities to predict negative returns. These findings generally support Pedersen’s predictions.

Keywords: social media, belief formation, return prediction, short selling, retail investors

JEL Classification: G11, G12, G14, G23