Guru Dreams and Competition: An Anatomy of the Economics of Blogs

Yi Dong

University of International Business and Economics

Massimo Massa

INSEAD – Finance

Hong Zhang

PBC School of Finance; INSEAD – Finance

INSEAD Working Paper No. 2014/59/FIN

H/T Joe weisenthal 

Abstract:

The rise of social media has encouraged guru dreams because of the low entry barrier and highly skewed distribution of public attention that characterize social media. The pursuit of guru status, however, may be achieved through information provision or cheap talk, and competition inherent to social media may incentivize participants to either process better information or express more extreme options. Using a unique dataset of blogs covering S&P 1500 stocks over the 2006-2011 period, we find evidence that social media can be informative about future stock returns but that competition distorts opinions rather than encouraging participants to process better information. In particular, competition induces exaggerated negative tones in blogs, which is unrelated to information. Our results suggest that social media may provide mixed incentives for its participants in terms of information efficiency.

Guru Dreams and Competition – Introduction

One of the most interesting phenomena of the last decade has been the rise in popularity of social media. Unlike traditional media, social media are characterized by a low barrier to entry and very high potential for speedy public diffusion. Indeed, the Internet allows almost anyone who can use web-based technology to express his or her opinions. Any individual can, for instance, create a blog at nearly zero cost and use it to express opinions on almost anything, ranging from stock valuation and political issues to fashion, culture, and so on. More important, the vast body of Internet users provides bloggers with a large group of potential followers. Blogging therefore allows individuals to become salient and to attract public attention in a way that is unachievable with the traditional media. Nevertheless, the possibility of monopolizing public attention is concentrated in a very small fraction of bloggers—i.e., the distribution of public attention for blogs is highly skewed. These features lay out incentives for bloggers that can be loosely defined as the “dream to become a guru” (e.g., Rosen, 1981).

Two interesting questions arise: First, should “gurus-to-be” bloggers be more informed than public media? Second, given the low entry costs of blogging, how does competition affect bloggers’ behavior and shape their dreams to become gurus? The answers to these questions are crucial for understanding the economics of social media.

In this paper, we address these questions by using a unique hand-collected database of blogs covering all S&P 1500 stocks over the 2006-2011 period from LexisNexis. We start by investigating whether bloggers are informed. We entertain two alternative hypotheses. The first posits that if the objective of bloggers is to become “gurus,” bloggers must release some non-public information to build a long-term reputation. Bloggers may be more informed than the public either because they are better able to process information or because they are privy to more private information. We label this hypothesis the informed guru hypothesis. The alternative hypothesis posits that bloggers are not more informed than public media; rather, they simply selectively rephrase what is already published in the public media to attract attention. We label this hypothesis the cheap-talk hypothesis.

We first investigate whether blog coverage is related to more informed trading in general. We therefore relate the presence of blogs to two stock characteristics that proxy for informed trading and liquidity trading. The first proxy is the C2 measure from Llorente, Michaely, Saar, and Wang (2002), which exploits the impact of trading volume on return autocorrelation to distinguish between liquidity trading and informed trading. The second proxy is the unformed flows of mutual funds. We document that blog coverage is positively related to informed trading and negatively related to uninformed liquidity trading. These results shed initial light on the possibility that blog coverage is correlated with informed rather than uninformed trading.

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Guru Dreams