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

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Author Info
Ivan Pastine (University College Dublin)
Tuvana Pastine (National University of Ireland Maynooth)

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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 permits the analysis of comparative statics results. The effect of an increase in signal quality on the likelihood of an inefficient cascade is shown to be nonmonotonic. 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, may be more prone to inefficient collapses.

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File URL: http://www.ucd.ie/economics/research/papers/2006/WP06.21.pdf
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File Function: First version, 2006
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Paper provided by School Of Economics, University College Dublin in its series Working Papers with number 200621.

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Length: 42 pages
Date of creation: 29 Nov 2006
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Handle: RePEc:ucn:wpaper:200621

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Related research
Keywords: Comparative Statics; Herding; Herd Manipulation;

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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.:
  1. Bikhchandani, Sushil & Hirshleifer, David & Welch, Ivo, 1998. "Learning from the Behavior of Others: Conformity, Fads, and Informational Cascades," Journal of Economic Perspectives, American Economic Association, vol. 12(3), pages 151-70, Summer. [Downloadable!] (restricted)
  2. 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. [Downloadable!] (restricted)
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  3. Beatty, Randolph P. & Ritter, Jay R., 1986. "Investment banking, reputation, and the underpricing of initial public offerings," Journal of Financial Economics, Elsevier, vol. 15(1-2), pages 213-232. [Downloadable!] (restricted)
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  4. Maskin, Eric & Tirole, Jean, 1988. "A Theory of Dynamic Oligopoly, II: Price Competition, Kinked Demand Curves, and Edgeworth Cycles," Econometrica, Econometric Society, vol. 56(3), pages 571-99, May. [Downloadable!] (restricted)
  5. Banerjee, Abhijit V, 1992. "A Simple Model of Herd Behavior," The Quarterly Journal of Economics, MIT Press, vol. 107(3), pages 797-817, August. [Downloadable!] (restricted)
  6. V.V. Chari & Patrick J. Kehoe, 2003. "Hot money," Staff Report 228, Federal Reserve Bank of Minneapolis. [Downloadable!]
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  7. Welch, Ivo, 1992. " Sequential Sales, Learning, and Cascades," Journal of Finance, American Finance Association, vol. 47(2), pages 695-732, June. [Downloadable!] (restricted)
  8. Christophe Chamley, 2003. "Dynamic Speculative Attacks," American Economic Review, American Economic Association, vol. 93(3), pages 603-621, June. [Downloadable!]
  9. Bikhchandani, Sushil & Hirshleifer, David & Welch, Ivo, 1992. "A Theory of Fads, Fashion, Custom, and Cultural Change in Informational Cascades," Journal of Political Economy, University of Chicago Press, vol. 100(5), pages 992-1026, October. [Downloadable!] (restricted)
  10. Avery, Christopher & Zemsky, Peter, 1998. "Multidimensional Uncertainty and Herd Behavior in Financial Markets," American Economic Review, American Economic Association, vol. 88(4), pages 724-48, September. [Downloadable!] (restricted)
  11. Gale, Douglas, 1996. "What have we learned from social learning?," European Economic Review, Elsevier, vol. 40(3-5), pages 617-628, April. [Downloadable!] (restricted)
  12. Devenow, Andrea & Welch, Ivo, 1996. "Rational herding in financial economics," European Economic Review, Elsevier, vol. 40(3-5), pages 603-615, April. [Downloadable!] (restricted)
  13. Lones Smith & Peter Sorensen, 2000. "Pathological Outcomes of Observational Learning," Econometrica, Econometric Society, vol. 68(2), pages 371-398, March.
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  14. 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. [Downloadable!] (restricted)
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  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, Blackwell Publishing, vol. 50(1), pages 57-84, March. [Downloadable!] (restricted)
  16. Scharfstein, David S & Stein, Jeremy C, 1990. "Herd Behavior and Investment," American Economic Review, American Economic Association, vol. 80(3), pages 465-79, June.
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  17. Lee Nelson, 2002. "Persistence and Reversal in Herd Behavior: Theory and Application to the Decision to Go Public," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 15(1), pages 65-95, March.
  18. Mathias Drehmann & Jorg Oechssler & Andreas Roider, 2005. "Herding and Contrarian Behavior in Financial Markets: An Internet Experiment," American Economic Review, American Economic Association, vol. 95(5), pages 1403-1426, December. [Downloadable!]
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Cited by:
(explanations, 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.)

  1. Pastine, Ivan & Pastine, Tuvana, 2005. "Signal Accuracy and Informational Cascades," CEPR Discussion Papers 5219, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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