People regularly interact with their family, friends, and colleagues, but the effects of such social interactions on economic and financial decision-making are not well understood. Do such interactions influence people’s assessment of the attractiveness of investments such as houses or stocks, and if so, is the actual investment behaviour of those people affected? Are individuals more likely to purchase a new product when their friends have recently bought the same or a similar product? Which individuals are particularly influential, and which individuals are more likely to be influenced?

Together with Mike Bailey at Facebook and a number of other co-authors, we have studied these and other questions in a recent series of papers. In this note, we review the main findings from some of this research.

The effects of social interactions in the housing market

In a sequence of papers, we explore how social interactions affect individuals’ beliefs about the attractiveness of housing market investments and their actual housing investment decisions.

To measure individuals’ housing market beliefs, Facebook conducted an online survey of some of its users in Los Angeles County. In this survey we could see that individuals living in the same zip codes have very different expectations about local housing markets. We then matched individuals’ survey responses to anonymised data on the geographic location of their Facebook friends. We found that individuals who has friends that live in parts of the U.S. where house prices had recently gone up were more optimistic about local Los Angeles housing market investments than individuals who had friends in parts of the country where house prices had not done so well. All of this effect was driven by people who reported that they regularly talked with their friends about housing markets. We concluded that by talking to their friends, individuals seem to update their own expectations about housing investment opportunities based on the recent experiences of their friends.

After showing that friends’ house price experiences influence the way people perceive housing market investments, we investigated whether social interactions with these friends also affected their decisions to invest in real estate. To do so, we examined anonymised public record deeds data of Los Angeles-based Facebook users focusing on three aspects of housing market behaviour: the likelihood of a renter becoming a homeowner, the size of the purchased house and the price paid for the home.

We found that renters are 3.1 percentage points more likely to buy a home over the next two years for ever 5 percentage point increase in the house price changes experienced by their friends. This effect is large relative to an 18 per cent baseline probability of someone in the sample becoming a homeowner during that period of time. Individuals whose friends experienced a 5 percentage point larger house price increase also buy houses that are, on average, 1.7 per cent larger and are willing to pay 3.3 per cent more for a given property. Conversely, homeowners whose friends experienced housing price decreases are more likely to sell their properties and become renters.

Overall, these findings on the investment behaviour of individuals are highly consistent with our conclusions from the expectation survey: people who experience substantial house price growth in their social network become more optimistic about their local housing market, and actually end up investing more in real estate.

More generally, our results highlight that individuals’ investment decisions are not made in a social vacuum. What we hear from our friends affects how attractive we perceive an asset to be, even if the experience of those friends arguably does not contain a lot of information that is relevant for the true valuation of the asset. This runs counter to the assumptions in many of our models meant to study the economy. On the flip side, this evidence might help us understand how the passing-on of optimism about the valuation of certain assets might lead to price bubbles in both the housing market and in the stock market.

Peer effects in product adoption

In recent work, we also explored the role of social interactions for product adoption decisions. In particular, we studied the market for cell phones to understand how a new phone purchased by a friend affects a person’s own phone purchasing probability and to what extent such peer effects are specific to the same brand or actual phone model purchased by the friend.

We worked again with anonymised data from Facebook that includes information on both individuals’ social networks and the types of phones used by all mobile-active users. This allowed us to observe when an individual and her friends purchased new phones.

We found that having a friend who purchases a new phone has a substantial and long-lasting effect on a person’s own probability of getting a new phone – one more friend that buys a new phone increase my own probability of buying a new phone in the following week by about 3 per cent. Hence, the value to firms of acquiring new customers goes much beyond the direct effect of these customers on firm profits. Instead, it is important to consider any further sales that these customers create through peer effects.

We also explore which individuals are particularly influential, and find that phone purchases by younger and less educated people have larger effects on the purchasing behaviour of their friends. In addition, it turns out that the individuals who are the most influential are also the most price sensitive — this suggests that, by reducing the price, firms can attract substantial new demand from precisely those people who will generate further follow-on sales. This feature will likely result in lower prices for cell phones than would prevail in the absence of peer effects.

Our evidence also suggests that social learning contributes substantially to the observed peer effects: when a friend purchases a new phone, their purchase allows me to learn about features I would not have otherwise learned about, making me more likely to buy that specific phone. Consistent with this, we find that the peer effects from a friends’ purchase of a new iPhone are smaller than the effects of a friends’ purchase of a phone of a less-well-known brand. This highlights the value of word-of-mouth marketing through peer effects for new entrants into a market.

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Notes:

• This blog is based on the authors’ paper The Economic Effects of Social Networks: Evidence from the Housing Market, Journal of Political Economy, 2018.
• The post gives the views of its author, not the position of LSE Business Review or the London School of Economics.
• Featured image by mastersenaiper, under a Pixabay licence
• Before commenting, please read our Comment Policy

Theresa Kuchler is an assistant professor of finance at NYU’s Stern School of Business. She conducts research in the areas of household, behavioural finance and social networks, often involving large micro datasets. She has studied the role of present bias for debt paydown using transaction-level account data. More recently, she has focused on how individuals form expectations about aggregate outcomes and the role of social networks in forming expectations and influencing financial decisions. Ongoing research further explores the role of social networks in shaping individual decisions. She has a Ph.D. in economics from Stanford University.

Johannes Stroebel is a professor of finance and Boxer faculty fellow at NYU’s Stern School of Business. He was previously the Neubauer Family assistant professor of economics at the University of Chicago’s Booth School of Business. Professor Stroebel conducts research in finance, macroeconomics, and real estate economics. He has won numerous awards, including the AQR Asset Management Institute Young Researcher Prize and the Brattle Award for the best paper published in the Journal of Finance. He read Philosophy, Politics, and Economics at Merton College, Oxford, where he won the Hicks and Webb Medley Prize for the best performance in economics. He earned a Ph.D. in Economics at Stanford University.

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