Ethnic diversity prevents market bubbles: Study

Enhancing ethnic diversity on the world's financial trading floors is a recipe for deflating devastating bubbles and increasing profits, data from a new study showed.

"Ethnic diversity is a value in itself. What we show is that it can economically also be valuable in market efficiency terms," said David Stark, a professor of sociology and international affairs at Columbia University.

Across markets and locations, pricing accuracy was 58 per cent higher in diverse markets, as was the ability to thwart pricing bubbles, the study by the Proceedings of the National Academy of Sciences found.

"Traders in ethnically homogenous markets are significantly less accurate, and thus more likely to cause price bubbles," the paper said. Results showed their performance worsened over time.

"Diversity facilitates friction. In markets, this friction can disrupt conformity, interrupt taken-for-granted routines and prevent herding," the paper said.

The study was conducted among people from East Asia and the Southwest United States. It measured a baseline of financial literacy among the participants. They were placed in a simulated trading environment and set the task of trying to earn money, while the researchers measured their pricing accuracy through a commonly used real-life trading terminal. Their identities were anonymous and participants kept what they earned.

"They could look around them and see who was in the room, but they didn't talk to each other," said the lead author of the report, Sheen Levine, principal investigator at Columbia's Institute for Social and Economic Research and Policy.

"There is an established finding across the social sciences that we tend to trust the actions and beliefs of people that look like us. All the assumptions they are making are a very superficial impression of what the other guy looks like. They don't know if he's reasonable."

The study started in Singapore in 2009, with US trading sessions in 2012 and 2013, said Levine. In the US portion of the study, the researchers spent well over US$10,000.

"Ethnic diversity was valuable not necessarily because minority traders contributed unique information or skills, but their mere presence changed the tenor of decision-making among all traders. Diversity benefited the market," the study said.

Asked if gender also played a role in the study's results, Levine said this was not looked at specifically, "but gender diversity is the next topic of study".