How Does “Information Cascade” Differ from the Herding Effect in Financial Markets?

The herding effect is driven by emotional and psychological factors, where investors follow the crowd out of fear or greed, often ignoring their own information. An information cascade, however, is a rational decision-making process.

It occurs when investors, seeing the actions of others, rationally conclude that the initial actors must have superior information. They then disregard their own private, less certain information and follow the trend, leading to a potentially misinformed consensus.