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Saturation Effect and Cyclical Herd Behavior

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  • Patarick Leoni

    () (Economics Department, National University of Ireland, Maynooth)

Abstract

We analyze a sequential decision model, where in every period a new agent seeks to determine the payoff of some actions. Every agent receives a possibly uninformative signal about the payoffs, and she observes previous choices. Some actions have a saturation effect; i.e., their payoffs become zero if used repeatedly too often albeit the original payoff is recovered later. We show that in every equilibrium and for almost every equilibrium play path, an action will trigger a cyclical herd behavior. We also show that the length of the transition phase between two consecutive herd behavior is at most the time needed to recover from the saturation effect. We thus give an alternative explanation to Kirman (1993) for the cyclicity of herd behavior, based on the negative externality generated by the repeated use of the same action.

Suggested Citation

  • Patarick Leoni, 2006. "Saturation Effect and Cyclical Herd Behavior," Economics, Finance and Accounting Department Working Paper Series n1690906, Department of Economics, Finance and Accounting, National University of Ireland - Maynooth.
  • Handle: RePEc:may:mayecw:n1690906
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    File URL: http://repec.maynoothuniversity.ie/mayecw-files/N1690906.pdf
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    References listed on IDEAS

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    1. Alan Kirman, 1993. "Ants, Rationality, and Recruitment," The Quarterly Journal of Economics, Oxford University Press, vol. 108(1), pages 137-156.
    2. Katz, Michael L & Shapiro, Carl, 1985. "Network Externalities, Competition, and Compatibility," American Economic Review, American Economic Association, pages 424-440.
    3. Scharfstein, David. & Stein, Jeremy C., 1988. "Herd behavior and investment," Working papers WP 2062-88., Massachusetts Institute of Technology (MIT), Sloan School of Management.
    4. 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.
    5. Scharfstein, David S & Stein, Jeremy C, 1990. "Herd Behavior and Investment," American Economic Review, American Economic Association, pages 465-479.
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    Keywords

    Herd behavior; Cycles; Saturation effects.;

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