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Signal Accuracy and Informational Cascades


  • Pastine, Ivan
  • Pastine, Tuvana


In an observational learning environment, rational agents with incomplete information may mimic the actions of their predecessors even when their own signal suggests the opposite. This herding behaviour may lead the society to an inefficient outcome if the signals of the early movers happen to be incorrect. This paper analyses the effect of signal accuracy on the probability of an inefficient informational cascade. The literature so far has suggested that an increase in signal accuracy leads to a decline in the probability of inefficient herding, because the first movers are more likely to make the correct choice. Indeed, the simulation results in Bikhchandani, Hirshleifer and Welch (1992) support this proposition. This paper however shows this not to be the case in general. We present simulations that demonstrate that even a small departure from symmetry in signal accuracy may lead to non-monotonic results. An increase in signal accuracy may result in a higher likelihood of an inefficient cascade.

Suggested Citation

  • Pastine, Ivan & Pastine, Tuvana, 2005. "Signal Accuracy and Informational Cascades," CEPR Discussion Papers 5219, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:5219

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    References listed on IDEAS

    1. Neeman, Zvika & Orosel, Gerhard O., 1999. "Herding and the Winner's Curse in Markets with Sequential Bids," Journal of Economic Theory, Elsevier, vol. 85(1), pages 91-121, March.
    2. Angela A. Hung & Charles R. Plott, 2001. "Information Cascades: Replication and an Extension to Majority Rule and Conformity-Rewarding Institutions," American Economic Review, American Economic Association, vol. 91(5), pages 1508-1520, December.
    3. Chamley, Christophe & Gale, Douglas, 1994. "Information Revelation and Strategic Delay in a Model of Investment," Econometrica, Econometric Society, vol. 62(5), pages 1065-1085, September.
    4. Avery, Christopher & Zemsky, Peter, 1998. "Multidimensional Uncertainty and Herd Behavior in Financial Markets," American Economic Review, American Economic Association, vol. 88(4), pages 724-748, September.
    5. De Vany, Arthur & Lee, Cassey, 2001. "Quality signals in information cascades and the dynamics of the distribution of motion picture box office revenues," Journal of Economic Dynamics and Control, Elsevier, vol. 25(3-4), pages 593-614, March.
    6. Pastine, Tuvana, 2005. "Social Learning in Continuous Time: When are Informational Cascades More Likely to be Inefficient?," CEPR Discussion Papers 5120, C.E.P.R. Discussion Papers.
    7. Scharfstein, David S & Stein, Jeremy C, 1990. "Herd Behavior and Investment," American Economic Review, American Economic Association, vol. 80(3), pages 465-479, June.
    8. 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.
    9. Choi, Chong Ju & Dassiou, Xeni & Gettings, Stephen, 2000. "Herding Behaviour and the Size of Customer Base as a Commitment to Quality," Economica, London School of Economics and Political Science, vol. 67(267), pages 375-398, August.
    10. repec:cup:apsrev:v:93:y:1999:i:01:p:51-67_21 is not listed on IDEAS
    11. Welch, Ivo, 1992. " Sequential Sales, Learning, and Cascades," Journal of Finance, American Finance Association, vol. 47(2), pages 695-732, June.
    12. Anderson, Lisa R & Holt, Charles A, 1997. "Information Cascades in the Laboratory," American Economic Review, American Economic Association, vol. 87(5), pages 847-862, December.
    13. Devenow, Andrea & Welch, Ivo, 1996. "Rational herding in financial economics," European Economic Review, Elsevier, vol. 40(3-5), pages 603-615, April.
    14. Kennedy, Robert E, 2002. "Strategy Fads and Competitive Convergence: An Empirical Test for Herd Behavior in Prime-Time Television Programming," Journal of Industrial Economics, Wiley Blackwell, vol. 50(1), pages 57-84, March.
    15. Lee Nelson, 2002. "Persistence and Reversal in Herd Behavior: Theory and Application to the Decision to Go Public," Review of Financial Studies, Society for Financial Studies, vol. 15(1), pages 65-95, March.
    16. Abhijit V. Banerjee, 1992. "A Simple Model of Herd Behavior," The Quarterly Journal of Economics, Oxford University Press, vol. 107(3), pages 797-817.
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    Cited by:

    1. Wu, Jiemai, 2015. "Helpful laymen in informational cascades," Journal of Economic Behavior & Organization, Elsevier, vol. 116(C), pages 407-415.
    2. Fiore, Annamaria & Morone, Andrea, 2008. "A Simple Note on Informational Cascades," Economics - The Open-Access, Open-Assessment E-Journal, Kiel Institute for the World Economy (IfW), vol. 2, pages 1-21.

    More about this item


    herding; social learning;

    JEL classification:

    • D80 - Microeconomics - - Information, Knowledge, and Uncertainty - - - General
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design

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