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Learning, Cascades, and Transaction Costs

  • Maria Grazia Romano

The paper analyzes the effect of transaction costs on social learning in an asset market with asymmetric information, sequential trading, and a competitive price mechanism. Both fixed and proportional transaction costs reduce the information content of trading orders and lead to informational cascades. If transaction costs are very high, an informational cascade may occur not only when beliefs converge on a specific asset value but also when there is extreme uncertainty about the asset's fundamental value. Finally, if the value in the bad state is sufficiently low, proportional transaction costs lead to an informational cascade only when prices are very high. Copyright 2007, Oxford University Press.

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Article provided by European Finance Association in its journal Review of Finance.

Volume (Year): 11 (2007)
Issue (Month): 3 ()
Pages: 527-560

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Handle: RePEc:oup:revfin:v:11:y:2007:i:3:p:527-560
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  1. Décamps, Jean-Paul & Lovo, Stefano, 2003. "Risk Aversion and Herd Behavior in Financial Markets," IDEI Working Papers 246, Institut d'Économie Industrielle (IDEI), Toulouse.
  2. Hirshleifer, David & Teoh, Siew Hong, 2001. "Herd Behavior and Cascading in Capital Markets: A Review and Synthesis," MPRA Paper 5186, University Library of Munich, Germany.
  3. Marco Cipriani & Antonio Guarino, 2005. "Herd Behavior in a Laboratory Financial Market," Experimental 0502002, EconWPA.
  4. 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.
  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. Kyle, Albert S, 1985. "Continuous Auctions and Insider Trading," Econometrica, Econometric Society, vol. 53(6), pages 1315-35, November.
  7. Cipriani Marco & Guarino Antonio, 2008. "Herd Behavior and Contagion in Financial Markets," The B.E. Journal of Theoretical Economics, De Gruyter, vol. 8(1), pages 1-56, October.
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