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Informational Externalities, Herding, and Incentives

  • Lluís Bru
  • Xavier Vives

A version of the herding prediction model with a rational-expectations flavor is reexamined in the light of incentive theory. The welfare loss at the market solution with respect to the incentive-efficient solution can be decomposed into an information externality term minus an incentive cost term. It is found that the inefficiency of herding at the market solution is low when the cost of providing incentives is high. When the cost of providing incentives is low (and this happens when prior information is diffuse), the incentive-efficient solution approaches the team solution that fully internalizes the information externality. Then the herding problem at the market solution is at its worst.

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Article provided by Mohr Siebeck, Tübingen in its journal Journal of Institutional and Theoretical Economics.

Volume (Year): 158 (2002)
Issue (Month): 1 (March)
Pages: 91-

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Handle: RePEc:mhr:jinste:urn:sici:0932-4569(200203)158:1_91:iehai_2.0.tx_2-_
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References listed on IDEAS
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  1. Vives, X., 1993. "Learning from Others," UFAE and IAE Working Papers 206.93, Unitat de Fonaments de l'Anàlisi Econòmica (UAB) and Institut d'Anàlisi Econòmica (CSIC).
  2. Vives, Xavier, 1993. "How Fast Do Rational Agents Learn?," Review of Economic Studies, Wiley Blackwell, vol. 60(2), pages 329-47, April.
  3. Vives, Xavier, 1996. "Social learning and rational expectations," European Economic Review, Elsevier, vol. 40(3-5), pages 589-601, April.
  4. Gul, Faruk & Lundholm, Russell, 1995. "Endogenous Timing and the Clustering of Agents' Decisions," Journal of Political Economy, University of Chicago Press, vol. 103(5), pages 1039-66, October.
  5. 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.
  6. Laffont, Jean-Jacques M, 1985. "On the Welfare Analysis of Rational Expectations Equilibria with Asymmetric Information," Econometrica, Econometric Society, vol. 53(1), pages 1-29, January.
  7. Smith, L. & Sorensen, P., 1996. "Pathological Outcomes of Observational Learning," Economics Papers 115, Economics Group, Nuffield College, University of Oxford.
  8. repec:tpr:qjecon:v:107:y:1992:i:3:p:797-817 is not listed on IDEAS
  9. Gale, Douglas, 1996. "What have we learned from social learning?," European Economic Review, Elsevier, vol. 40(3-5), pages 617-628, April.
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