Herd Behavior and Contagion in Financial Markets
We study a sequential trading financial market where there are gains from trade, i.e., where informed traders have heterogeneous private values. We show that an informational cascade (i.e., a complete blockage of information) arises and prices fail to aggregate information dispersed among traders. During an informational cascade, all traders with the same preferences choose the same action, either following the market (herding) or going against it (contrarianism). We also study financial contagion by extending our model to a two-asset economy. We show that informational cascades in one market can be generated by informational spillovers from the other. Such spillovers have pathological consequences, generating long-lasting misalignments between prices and fundamentals.
|Date of creation:|
|Date of revision:|
|Publication status:||Published in the B.E. Journal of Theoretical Economics, 8(1), Article 24, pp. 1-54, 2008|
|Contact details of provider:|| Web page: http://www.gwu.edu/~iiep/|
More information through EDIRC
When requesting a correction, please mention this item's handle: RePEc:gwi:wpaper:2010-01. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Kyle Renner)
If references are entirely missing, you can add them using this form.