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Beauty Contests and Irrational Exuberance: A Neoclassical Approach

  • George-Marios Angeletos
  • Guido Lorenzoni
  • Alessandro Pavan

The arrival of new, unfamiliar, investment opportunities is often associated with "exuberant" movements in asset prices and real economic activity. During these episodes of high uncertainty, financial markets look at the real sector for signals about the profitability of the new investment opportunities, and vice versa. In this paper, we study how such information spillovers impact the incentives that agents face when making their real economic decisions. On the positive front, we find that the sensitivity of equilibrium outcomes to noise and to higher-order uncertainty is amplified, exacerbating the disconnect from fundamentals. On the normative front, we find that these effects are symptoms of constrained inefficiency; we then investigate policies that can improve welfare in our model without any informational advantage on the government's part. At the heart of these results is a distortion that induces a conventional neoclassical economy to behave as a Keynesian "beauty contest" and to exhibit fluctuations that may look like "irrational exuberance" to an outside observer.

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Date of creation: 08 Oct 2010
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Handle: RePEc:cla:levarc:661465000000000237
Contact details of provider: Web page: http://www.dklevine.com/

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  1. Goldstein, Itay & Ozdenoren, Emre & Yuan, Kathy, 2010. "Trading Frenzies and Their Impact on Real Investment," CEPR Discussion Papers 7652, C.E.P.R. Discussion Papers.
  2. George-Marios Angeletos & Alessandro Pavan, 2007. "Policy with Dispersed Information," NBER Working Papers 13590, National Bureau of Economic Research, Inc.
  3. Amador, Manuel & Weill, Pierre-Olivier, 2006. "Learning from Private and Public Observation of Other's Actions," MPRA Paper 109, University Library of Munich, Germany.
  4. Maćkowiak, Bartosz & Wiederholt, Mirko, 2009. "Optimal sticky prices under rational inattention," Working Paper Series 1009, European Central Bank.
  5. Gilchrist, Simon & Himmelberg, Charles P. & Huberman, Gur, 2005. "Do stock price bubbles influence corporate investment?," Journal of Monetary Economics, Elsevier, vol. 52(4), pages 805-827, May.
  6. repec:bla:restud:v:77:y:2010:i:1:p:305-338 is not listed on IDEAS
  7. Manuel Amador & Pierre-Olivier Weill, 2008. "Learning from Prices: Public Communication and Welfare," NBER Working Papers 14255, National Bureau of Economic Research, Inc.
  8. James Dow & Gary Gorton, 1995. "Stock Market Efficiency and Economic Efficiency: Is There a Connection?," NBER Working Papers 5233, National Bureau of Economic Research, Inc.
  9. George-Marios Angeletos & Alessandro Pavan, 2007. "Efficient Use of Information and Social Value of Information," Econometrica, Econometric Society, vol. 75(4), pages 1103-1142, 07.
  10. Laura Veldkamp, 2004. "Media Frenzies in Markets for Financial Information," Econometric Society 2004 North American Winter Meetings 4, Econometric Society.
  11. 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).
  12. Cespa, Giovanni & Vives, Xavier, 2009. "Dynamic Trading and Asset Prices: Keynes vs. Hayek," CEPR Discussion Papers 7506, C.E.P.R. Discussion Papers.
  13. Xavier Vives, 2007. "Information and Learning in Markets," Levine's Bibliography 122247000000001520, UCLA Department of Economics.
  14. Franck Portier & Aude Pommeret & Olivier Loisel, 2008. "Monetary policy and herd behavior in new-tech investment," 2008 Meeting Papers 444, Society for Economic Dynamics.
  15. George-Marios Angeletos & Jennifer La'O, 2009. "Noisy Business Cycles," NBER Working Papers 14982, National Bureau of Economic Research, Inc.
    • George-Marios Angeletos & Jennifer La'O, 2010. "Noisy Business Cycles," NBER Chapters, in: NBER Macroeconomics Annual 2009, Volume 24, pages 319-378 National Bureau of Economic Research, Inc.
  16. Laura Veldkamp & Christian Hellwig, 2006. "Knowing What Others Know: Coordination Motives in Information Acquisition," Working Papers 06-14, New York University, Leonard N. Stern School of Business, Department of Economics.
  17. Itay Goldstein & Alexander Guembel & James Dow, 2008. "Incentives for Information Production in Markets where Prices Affect Real Investment," 2008 Meeting Papers 270, Society for Economic Dynamics.
  18. Christian Hellwig, . "Monetary Business Cycle Models: Imperfect Information (Review Article, March 2006)," UCLA Economics Online Papers 377, UCLA Department of Economics.
  19. Itay Goldstein & Alexander Guembel, 2008. "Manipulation and the Allocational Role of Prices," Review of Economic Studies, Oxford University Press, vol. 75(1), pages 133-164.
  20. George-Marios Angeletos & Guido Lorenzoni & Alessandro Pavan, 2007. "Wall Street and Silicon Valley: A Delicate Interaction," NBER Working Papers 13475, National Bureau of Economic Research, Inc.
  21. Dupor, Bill, 2005. "Stabilizing non-fundamental asset price movements under discretion and limited information," Journal of Monetary Economics, Elsevier, vol. 52(4), pages 727-747, May.
  22. David P. Myatt & Chris Wallace, 2012. "Endogenous Information Acquisition in Coordination Games," Review of Economic Studies, Oxford University Press, vol. 79(1), pages 340-374.
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