Herd Behavior and Contagion in Financial Markets
AbstractWe study a sequential trading financial market where there are gains from trade, that is, where informed traders have heterogeneous private values. We show that an informational cascade (i.e., a complete blockage of information) arises and prices fail to aggregate information dispersed among traders. During an informational cascade, all traders with the same preferences choose the same action, following the market (herding) or going against it (contrarianism). We also study financial contagion by extending our model to a two-asset economy. We show that informational cascades in one market can be generated by informational spillovers from the other. Such spillovers have pathological consequences, generating long-lasting misalignments between prices and fundamentals.
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Bibliographic InfoArticle provided by De Gruyter in its journal The B.E. Journal of Theoretical Economics.
Volume (Year): 8 (2008)
Issue (Month): 1 (October)
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Web page: http://www.degruyter.com
Other versions of this item:
- D8 - Microeconomics - - Information, Knowledge, and Uncertainty
- G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
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