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Social Learning in Continuous Time: When are Informational Cascades More Likely to be Inefficient?

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  • Pastine, Tuvana

Abstract

In an observational learning environment rational agents may mimic the actions of the predecessors even when their own signal suggests the opposite. In case early movers’ signals happen to be incorrect society may settle on a common inefficient action, resulting in an inefficient informational cascade. This paper models observational learning in continuous time with endogenous timing of moves. This is the first paper with homogenous access to information that gives an analytical approximation for the probability of inefficient cascades. This permits the analysis of comparative statics results. In contrast to the general impression in the literature, the effect of an increase in signal quality on the likelihood of an inefficient cascade is shown to be non-monotonic. If agents do not have strong priors, an increase in signal quality may lead to a higher probability of inefficient herding. The analysis also suggests that markets with quick response to investment decisions, such as financial markets, are more prone to inefficient collapses.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 5120.

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Date of creation: Jul 2005
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Handle: RePEc:cpr:ceprdp:5120

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Keywords: comparative statics; herd manipulation; herding;

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  1. Neeman, Zvika & Orosel, Gerhard O., 1999. "Herding and the Winner's Curse in Markets with Sequential Bids," Journal of Economic Theory, Elsevier, vol. 85(1), pages 91-121, March.
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  8. Sushil Bikhchandani & David Hirshleifer & Ivo Welch, 2010. "A theory of Fads, Fashion, Custom and cultural change as informational Cascades," Levine's Working Paper Archive 1193, David K. Levine.
  9. Scharfstein, David. & Stein, Jeremy C., 1988. "Herd behavior and investment," Working papers WP 2062-88., Massachusetts Institute of Technology (MIT), Sloan School of Management.
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  12. Olivier Gossner & Nicolas Melissas, 2004. "Informational Cascades Elicit Private Information," CIG Working Papers SP II 2004-19, Wissenschaftszentrum Berlin (WZB), Research Unit: Competition and Innovation (CIG).
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  14. Chamley, Christophe & Gale, Douglas, 1994. "Information Revelation and Strategic Delay in a Model of Investment," Econometrica, Econometric Society, vol. 62(5), pages 1065-85, September.
  15. Kennedy, Robert E, 2002. "Strategy Fads and Competitive Convergence: An Empirical Test for Herd Behavior in Prime-Time Television Programming," Journal of Industrial Economics, Wiley Blackwell, vol. 50(1), pages 57-84, March.
  16. Lee Nelson, 2002. "Persistence and Reversal in Herd Behavior: Theory and Application to the Decision to Go Public," Review of Financial Studies, Society for Financial Studies, vol. 15(1), pages 65-95, March.
  17. Christophe Chamley, 2003. "Dynamic Speculative Attacks," American Economic Review, American Economic Association, vol. 93(3), pages 603-621, June.
  18. Gale, Douglas, 1996. "What have we learned from social learning?," European Economic Review, Elsevier, vol. 40(3-5), pages 617-628, April.
  19. Welch, Ivo, 1992. " Sequential Sales, Learning, and Cascades," Journal of Finance, American Finance Association, vol. 47(2), pages 695-732, June.
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Cited by:
  1. Pastine, Ivan & Pastine, Tuvana, 2005. "Signal Accuracy and Informational Cascades," CEPR Discussion Papers 5219, C.E.P.R. Discussion Papers.

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