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Social Learning in Continuous Time - When are Informational Cascades More Likely to be Inefficient?

  • Ivan Pastine

    (University College Dublin)

  • Tuvana Pastine

    (National University of Ireland Maynooth)

In an observational learning environment rational agents may mimic the actions of the predecessors even when their own signal suggests the opposite. In case early movers’ signals happen to be incorrect society may settle on a common inefficient action, resulting in an inefficient informational cascade. This paper models observational learning in continuous time with endogenous timing of moves. This permits the analysis of comparative statics results. The effect of an increase in signal quality on the likelihood of an inefficient cascade is shown to be nonmonotonic. If agents do not have strong priors, an increase in signal quality may lead to a higher probability of inefficient herding. The analysis also suggests that markets with quick response to investment decisions, such as financial markets, may be more prone to inefficient collapses.

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File URL: http://www.ucd.ie/economics/research/papers/2006/WP06.21.pdf
File Function: First version, 2006
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Paper provided by School of Economics, University College Dublin in its series Working Papers with number 200621.

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Length: 42 pages
Date of creation: 29 Nov 2006
Date of revision:
Handle: RePEc:ucn:wpaper:200621
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  1. Drehmann, Mathias & Oechssler, Joerg & Roider, Andreas, 2003. "Herding and Contrarian Behavior in Financial Markets: An Internet Experiment," University of California at Santa Barbara, Economics Working Paper Series qt6zf5469f, Department of Economics, UC Santa Barbara.
  2. Gale, Douglas, 1996. "What have we learned from social learning?," European Economic Review, Elsevier, vol. 40(3-5), pages 617-628, April.
  3. 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.
  4. Olivier Gossner & Nicholas Melissas, 2003. "Informational cascades elicit private information," Discussion Papers in Economics 03/6, Department of Economics, University of Leicester.
  5. Smith, L. & Sorensen, P., 1996. "Pathological Outcomes of Observational Learning," Working papers 96-19, Massachusetts Institute of Technology (MIT), Department of Economics.
  6. Zvika NEEMAN & Gerhard O. OROSEL, 1997. "Herding and the Winner's Curse in Markets with Sequential Bids," Vienna Economics Papers vie9711, University of Vienna, Department of Economics.
  7. Beatty, Randolph P. & Ritter, Jay R., 1986. "Investment banking, reputation, and the underpricing of initial public offerings," Journal of Financial Economics, Elsevier, vol. 15(1-2), pages 213-232.
  8. 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.
  9. Banerjee, Abhijit V, 1992. "A Simple Model of Herd Behavior," The Quarterly Journal of Economics, MIT Press, vol. 107(3), pages 797-817, August.
  10. Scharfstein, David S & Stein, Jeremy C, 1990. "Herd Behavior and Investment," American Economic Review, American Economic Association, vol. 80(3), pages 465-79, June.
  11. Levin, Dan & Peck, James, 2008. "Investment dynamics with common and private values," Journal of Economic Theory, Elsevier, vol. 143(1), pages 114-139, November.
  12. Sushil Bikhchandani & David Hirshleifer & Ivo Welch, 1998. "Learning from the Behavior of Others: Conformity, Fads, and Informational Cascades," Journal of Economic Perspectives, American Economic Association, vol. 12(3), pages 151-170, Summer.
  13. 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.
  14. Avery, Christopher & Zemsky, Peter, 1998. "Multidimensional Uncertainty and Herd Behavior in Financial Markets," American Economic Review, American Economic Association, vol. 88(4), pages 724-48, September.
  15. Gale, D. & Chamley, C., 1992. "Information Revelation and Strategic Delay in a Model of Investment," Papers 10, Boston University - Department of Economics.
  16. Maskin, Eric & Tirole, Jean, 1988. "A Theory of Dynamic Oligopoly, II: Price Competition, Kinked Demand Curves, and Edgeworth Cycles," Econometrica, Econometric Society, vol. 56(3), pages 571-99, May.
  17. Devenow, Andrea & Welch, Ivo, 1996. "Rational herding in financial economics," European Economic Review, Elsevier, vol. 40(3-5), pages 603-615, April.
  18. Christophe Chamley, 2003. "Dynamic Speculative Attacks," American Economic Review, American Economic Association, vol. 93(3), pages 603-621, June.
  19. Welch, Ivo, 2000. "Herding among security analysts," Journal of Financial Economics, Elsevier, vol. 58(3), pages 369-396, December.
  20. 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.
  21. Welch, Ivo, 1992. " Sequential Sales, Learning, and Cascades," Journal of Finance, American Finance Association, vol. 47(2), pages 695-732, June.
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