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Informational cascades with endogenous prices: The role of risk aversion

  • Decamps, Jean-Paul
  • Lovo, Stefano

In this paper, we show that long run market informational inefficiency and informational cascades can easily happen when trades occur at market clearing prices. We consider a sequential trade model where: (i) the investors' set of actions is discrete; (ii) dealers and investors differ in risk aversion; (iii) investors' information is bounded. We show that informational cascade occurs as soon as traders' beliefs do not differ too sharply. Thus, prices cannot fully incorporate the private information dispersed in the economy

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Article provided by Elsevier in its journal Journal of Mathematical Economics.

Volume (Year): 42 (2006)
Issue (Month): 1 (February)
Pages: 109-120

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Handle: RePEc:eee:mateco:v:42:y:2006:i:1:p:109-120
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  1. Kyle, Albert S, 1985. "Continuous Auctions and Insider Trading," Econometrica, Econometric Society, vol. 53(6), pages 1315-35, November.
  2. Biais, Bruno & Martimort, David & Rochet, Jean-Charles, 1998. "Competing Mechanisms in a Commun Value Environment," IDEI Working Papers 75, Institut d'Économie Industrielle (IDEI), Toulouse.
  3. Xavier Vives, 1992. "The Speed of Information Revelation in a Financial Market Mechanism," CEPR Financial Markets Paper 0016, European Science Foundation Network in Financial Markets, c/o C.E.P.R, 77 Bastwick Street, London EC1V 3PZ..
  4. Lones Smith & Peter Sorensen, 2000. "Pathological Outcomes of Observational Learning," Econometrica, Econometric Society, vol. 68(2), pages 371-398, March.
  5. Glosten, Lawrence R, 1989. "Insider Trading, Liquidity, and the Role of the Monopolist Specialist," The Journal of Business, University of Chicago Press, vol. 62(2), pages 211-35, April.
  6. 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.
  7. In Ho Lee, 1998. "Market Crashes and Informational Avalanches," Review of Economic Studies, Oxford University Press, vol. 65(4), pages 741-759.
  8. Glosten, Lawrence R. & Milgrom, Paul R., 1985. "Bid, ask and transaction prices in a specialist market with heterogeneously informed traders," Journal of Financial Economics, Elsevier, vol. 14(1), pages 71-100, March.
  9. Chamley,Christophe P., 2004. "Rational Herds," Cambridge Books, Cambridge University Press, number 9780521530927, November.
  10. Chamley,Christophe P., 2004. "Rational Herds," Cambridge Books, Cambridge University Press, number 9780521824019, November.
  11. Marco Cipriani & Antonio Guarino, . "Herd Behavior and Contagion in Financial Markets," Working Papers 2010-01, The George Washington University, Institute for International Economic Policy.
  12. Abhijit V. Banerjee, 1992. "A Simple Model of Herd Behavior," The Quarterly Journal of Economics, Oxford University Press, vol. 107(3), pages 797-817.
  13. Easley, David & O'Hara, Maureen, 1992. " Time and the Process of Security Price Adjustment," Journal of Finance, American Finance Association, vol. 47(2), pages 576-605, June.
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