Learning of the others' success in investing leads to a significant increase in risk taking of subjects; even more true with copy trading (getting info on the other agents in financial markets and to directly copy their trades)

Copy Trading. Jose Apesteguia, Jörg Oechssler, Simon Weidenholzer. Management Science, Jul 14 2020. https://doi.org/10.1287/mnsc.2019.3508

Abstract: Copy trading allows traders in social networks to receive information on the success of other agents in financial markets and to directly copy their trades. Internet platforms like eToro, ZuluTrade, and Tradeo have attracted millions of users in recent years. The present paper studies the implications of copy trading for the risk taking of investors. Implementing a novel experimental financial asset market, we show that providing information on the success of others leads to a significant increase in risk taking of subjects. This increase in risk taking is even larger when subjects are provided with the option to directly copy others. We conclude that copy trading leads to excessive risk taking.


7  Discussion
In this paper we have experimentally shown that providing investors with information on previous investment decisions and the success of other traders may lead to an increase in risk taking. This effect may be further exacerbated when investors are allowed to directly copy other traders. Imitation through either of these channels may lead to a reduction of investors’ welfare, as judged from the elicitation of risk preferences and as manifested in counterfactual investment decisions where imitation is not possible. Our results, thus, suggest that social trading (with or without the option to directly copy others) may be detrimental to consumer welfare. Moreover, even outside of the domain of copy trading, information on the success of others may lead to excessive risk taking and reduced welfare.
We hope this paper will trigger more research in the near future in order to better understand behavior in copy trading platforms. For example, future research should be conducted in order to understand what are the reasons that lead to copy trading, or to more risk taking behavior in the INFO and COPY treatments. One possibility is that copiers attribute higher skills to copied investors. Although the design of our experiment made the role of luck very salient, future work should systematically study this possibility. Also, it has been shown that cognitive abilities or personality traits are related to risk taking behavior (see, e.g., Dohmen et al., 2010; Eisenbach and Schmalz, 2016; Harbaugh, 2006). In this respect it seems relevant to explore whether these characteristics may prompt some subjects to copy others, or to be more affected by the performance of others. Moreover, while we have recruited our participants from a student subject pool, investors on copy trading platforms likely join these platforms with the explicit intent to engage in copy trading. Whether the welfare consequences of investors on copy trading platforms are larger or lower than in the student population is another open question that should be addressed in future research.
One should of course be very cautious at extrapolating conclusions from the lab to the field, in particular before a good deal of lab and field research has been conducted on the subject matter. However, there are reason to believe that the implications of copy trading on risk taking may be even stronger on real world copy trading platforms. For example, in the real world, investors’ beliefs on the skills and information of leaders might be even more optimistic than in our laboratory setting. In addition, whereas our experimental setup, by way of the simulator, allowed subjects to easily assess how risky previous investments of other investors were, such an assessment is much more difficult in the real world. Finally, from a social perspective, imitation encourages traders to follow similar investment strategies and could, thus, lead to financial risk through resulting herding and contribute to the formation of financial bubbles.