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Informational Externalities, Herding and Incentives

  • Bru, Lluís
  • Vives, Xavier

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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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 3080.

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Date of creation: Nov 2001
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Handle: RePEc:cpr:ceprdp:3080
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  1. Banerjee, Abhijit V, 1992. "A Simple Model of Herd Behavior," The Quarterly Journal of Economics, MIT Press, vol. 107(3), pages 797-817, August.
  2. Vives, X., 1990. "How Fast Do Rational Agents Learn?," UFAE and IAE Working Papers 135-90, Unitat de Fonaments de l'Anàlisi Econòmica (UAB) and Institut d'Anàlisi Econòmica (CSIC).
  3. Smith, L. & Sorensen, P., 1996. "Pathological Outcomes of Observational Learning," Economics Papers 115, Economics Group, Nuffield College, University of Oxford.
  4. 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).
  5. 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.
  6. 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.
  7. 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.
  8. Vives, X..A., 1995. "Social Learning and Rational Expectations," UFAE and IAE Working Papers 305.95, Unitat de Fonaments de l'Anàlisi Econòmica (UAB) and Institut d'Anàlisi Econòmica (CSIC).
  9. Gale, Douglas, 1996. "What have we learned from social learning?," European Economic Review, Elsevier, vol. 40(3-5), pages 617-628, April.
  10. repec:cup:cbooks:9780521474009 is not listed on IDEAS
  11. repec:cup:cbooks:9780521479394 is not listed on IDEAS
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