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Learning in Crowded Markets

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  • Peter Kondor
  • Adam Zawadowski

Abstract

We study a capital reallocation problem in which investors can enter into a new market where they compete with each other in identifying the best deals. While ex ante investors are uncertain about their relative advantage in identifying the best deals, they can devote costly resources to learning about their relative advantage in a fully flexible way. We find that investors might allocate too much or too little capital to the new market. Increasing competition between investors induces them to learn more, shifting the distribution of entrants towards those with a relative advantage. However, competition does not change overall entry, so it does not affect the efficiency of capital allocation. Thus, learning induced by competition turns out to be wasteful and welfare decreasing. Allowing investors to learn in a fully flexible way - as opposed to requiring Gaussian signals - is what makes our argument transparent. We study several extension.

Suggested Citation

  • Peter Kondor & Adam Zawadowski, 2018. "Learning in Crowded Markets," CEU Working Papers 2018_4, Department of Economics, Central European University.
    • Handle: RePEc:ceu:econwp:2018_4
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    Cited by:

    1. Kondor, Péter & Zawadowski, Adam, 2019. "Learning in crowded markets," Journal of Economic Theory, Elsevier, vol. 184(C).
    2. Yang Hao, 2023. "Financial Market with Learning from Price under Knightian Uncertainty," Working Papers hal-03686748, HAL.
    3. Stepan Gorban & Anna A. Obizhaeva & Yajun Wang, 2020. "Trading in Crowded Markets," Working Papers w0275, New Economic School (NES).
    4. Bartosz Maćkowiak & Filip Matějka & Mirko Wiederholt, 2023. "Rational Inattention: A Review," Journal of Economic Literature, American Economic Association, vol. 61(1), pages 226-273, March.
    5. Fardeau, Vincent, 2023. "Sequential entry in illiquid markets," Journal of Financial Markets, Elsevier, vol. 64(C).

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    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)

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