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Informational Herding and Optimal Experimentation

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  • Lones Smith

    (Department of Economics, University of Michigan)

  • Peter Norman Sørensen

    (Department of Economics, University of Copenhagen)

Abstract

We show that far from capturing a formally new phenomenon, informational herding is really a special case of single-person experimentation - and `bad herds' the typical failure of complete learning. We then analyze the analogous team equilibrium, where individuals maximize the present discounted welfare of posterity. To do so, we generalize Gittins indices to our non-bandit learning problem, and thereby characterize when contrarian behaviour arises: (i) While herds are still constrained efficient, they arise for a strictly smaller belief set. (ii) A log-concave log-likelihood ratio density robustly ensures that individuals should lean more against their myopic preference for an action the more popular it becomes.

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Bibliographic Info

Paper provided by University of Copenhagen. Department of Economics in its series Discussion Papers with number 05-13.

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Length: 37 pages
Date of creation: Aug 2005
Date of revision:
Handle: RePEc:kud:kuiedp:0513

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Keywords: herding; optimal learning; experimentation; contrarianism;

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References

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  1. Smith, L. & Sorensen, P., 1996. "Pathological Outcomes of Observational Learning," Economics Papers 115, Economics Group, Nuffield College, University of Oxford.
  2. Sgroi, D., 2000. "Optimizing Information in the Herd: Guinea Pigs, Profit and Welfare," Economics Papers 2000-w14, Economics Group, Nuffield College, University of Oxford.
  3. Amir, Rabah, 1996. "Sensitivity analysis of multisector optimal economic dynamics," Journal of Mathematical Economics, Elsevier, vol. 25(1), pages 123-141.
  4. 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.
  5. 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.
  6. Aghion, Philippe, et al, 1991. "Optimal Learning by Experimentation," Review of Economic Studies, Wiley Blackwell, vol. 58(4), pages 621-54, July.
  7. Matthew Doyle, 2010. "Informational externalities, strategic delay, and optimal investment subsidies," Canadian Journal of Economics, Canadian Economics Association, vol. 43(3), pages 941-966, August.
  8. Aghion Philippe & Bolton, Patrick & Harris Christopher & Jullien Bruno, 1991. "Optimal learning by experimentation," CEPREMAP Working Papers (Couverture Orange) 9104, CEPREMAP.
  9. Vives, X., 1990. "How Fast Do Rational Agents Learn?," UFAE and IAE Working Papers 135-90, Unitat de Fonaments de l'Anàlisi Econòmica (UAB) and Institut d'Anàlisi Econòmica (CSIC).
  10. Dow, James, 1991. "Search Decisions with Limited Memory," Review of Economic Studies, Wiley Blackwell, vol. 58(1), pages 1-14, January.
  11. Burdett, Kenneth, 1996. "Truncated means and variances," Economics Letters, Elsevier, vol. 52(3), pages 263-267, September.
  12. Banerjee, Abhijit V, 1992. "A Simple Model of Herd Behavior," The Quarterly Journal of Economics, MIT Press, vol. 107(3), pages 797-817, August.
  13. Rothschild, Michael, 1974. "A two-armed bandit theory of market pricing," Journal of Economic Theory, Elsevier, vol. 9(2), pages 185-202, October.
  14. McLennan, Andrew, 1984. "Price dispersion and incomplete learning in the long run," Journal of Economic Dynamics and Control, Elsevier, vol. 7(3), pages 331-347, September.
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Cited by:
  1. Alessandro Lizzeri & Marciano Siniscalchi, 2008. "Parental Guidance and Supervised Learning," The Quarterly Journal of Economics, MIT Press, vol. 123(3), pages 1161-1195, August.
  2. Jacob Goeree & Thomas Palfrey & Brian Rogers, 2004. "Self-Correcting Information Cascades," Levine's Bibliography 122247000000000153, UCLA Department of Economics.
  3. Matthew Doyle, 2010. "Informational externalities, strategic delay, and optimal investment subsidies," Canadian Journal of Economics, Canadian Economics Association, vol. 43(3), pages 941-966, August.
  4. Gleason, Kimberly C. & Mathur, Ike & Peterson, Mark A., 2004. "Analysis of intraday herding behavior among the sector ETFs," Journal of Empirical Finance, Elsevier, vol. 11(5), pages 681-694, December.
  5. Christos Koulovatianos & Leonard J. Mirman & Marc Santugini, 2006. "Investment in a Monopoly with Bayesian Learning," Vienna Economics Papers 0603, University of Vienna, Department of Economics.

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