In an observational learning environment, rational agents with incomplete information may mimic the actions of their predecessors even when their own signal suggests the opposite. This herding behaviour may lead the society to an inefficient outcome if the signals of the early movers happen to be incorrect. This paper analyses the effect of signal accuracy on the probability of an inefficient informational cascade. The literature so far has suggested that an increase in signal accuracy leads to a decline in the probability of inefficient herding, because the first movers are more likely to make the correct choice. Indeed, the simulation results in Bikhchandani, Hirshleifer and Welch (1992) support this proposition. This paper however shows this not to be the case in general. We present simulations that demonstrate that even a small departure from symmetry in signal accuracy may lead to non-monotonic results. An increase in signal accuracy may result in a higher likelihood of an inefficient cascade.
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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number
5219.
Find related papers by JEL classification: D80 - Microeconomics - - Information, Knowledge, and Uncertainty - - - General D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information
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References listed on IDEAS Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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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