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Informational cascades with endogenous prices: The role of risk aversion

Author

Listed:
  • Stefano Lovo

    (GREGH - Groupement de Recherche et d'Etudes en Gestion à HEC - HEC Paris - Ecole des Hautes Etudes Commerciales - CNRS - Centre National de la Recherche Scientifique)

  • J. P. Décamps
Abstract
In this paper, we show that long run market informational inefficiency and informational cascades can easily happen when trades occur at market clearing prices. We consider a sequential trade model where: (i) the investors' set of actions is discrete; (ii) dealers and investors differ in risk aversion; (iii) investors' information is bounded. We show that informational cascade occurs as soon as traders' beliefs do not differ too sharply. Thus, prices cannot fully incorporate the private information dispersed in the economy

Suggested Citation

  • Stefano Lovo & J. P. Décamps, 2006. "Informational cascades with endogenous prices: The role of risk aversion," Post-Print halshs-00009853, HAL.
    • Handle: RePEc:hal:journl:halshs-00009853
    DOI: 10.1016/j.jmateco.2005.03.002
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    References listed on IDEAS

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    1. Cipriani Marco & Guarino Antonio, 2008. "Herd Behavior and Contagion in Financial Markets," The B.E. Journal of Theoretical Economics, De Gruyter, vol. 8(1), pages 1-56, October.
    2. Marco Cipriani & Antonio Guarino, 2005. "Herd Behavior in a Laboratory Financial Market," American Economic Review, American Economic Association, vol. 95(5), pages 1427-1443, December.
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    7. Vives Xavier, 1995. "The Speed of Information Revelation in a Financial Market Mechanism," Journal of Economic Theory, Elsevier, vol. 67(1), pages 178-204, October.
    8. Abhijit V. Banerjee, 1992. "A Simple Model of Herd Behavior," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 107(3), pages 797-817.
    9. Lones Smith & Peter Sorensen, 2000. "Pathological Outcomes of Observational Learning," Econometrica, Econometric Society, vol. 68(2), pages 371-398, March.
    10. Chamley,Christophe P., 2004. "Rational Herds," Cambridge Books, Cambridge University Press, number 9780521530927, September.
    11. Glosten, Lawrence R, 1989. "Insider Trading, Liquidity, and the Role of the Monopolist Specialist," The Journal of Business, University of Chicago Press, vol. 62(2), pages 211-235, April.
    12. Chamley,Christophe P., 2004. "Rational Herds," Cambridge Books, Cambridge University Press, number 9780521824019, September.
    13. In Ho Lee, 1998. "Market Crashes and Informational Avalanches," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 65(4), pages 741-759.
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    Cited by:

    1. Christophe Bisière & Jean-Paul Décamps & Stefano Lovo, 2015. "Risk Attitude, Beliefs Updating, and the Information Content of Trades: An Experiment," Management Science, INFORMS, vol. 61(6), pages 1378-1397, June.
    2. Cipriani Marco & Guarino Antonio, 2008. "Herd Behavior and Contagion in Financial Markets," The B.E. Journal of Theoretical Economics, De Gruyter, vol. 8(1), pages 1-56, October.
    3. Sushil Bikhchandani & David Hirshleifer & Omer Tamuz & Ivo Welch, 2024. "Information Cascades and Social Learning," Journal of Economic Literature, American Economic Association, vol. 62(3), pages 1040-1093, September.
    4. Dieter Nautz, "undated". "Herding in financial markets: Bridging the gap between theory and evidence," BDPEMS Working Papers 2013002, Berlin School of Economics.
    5. Liu, Hong & Zhang, Zhixiang, 2011. "Insider trading with public and shared information," Economic Modelling, Elsevier, vol. 28(4), pages 1756-1762, July.
    6. Hirshleifer, David & Teoh, Siew Hong, 2008. "Thought and Behavior Contagion in Capital Markets," MPRA Paper 9164, University Library of Munich, Germany.
    7. Boortz, Christopher, 2016. "Irrational exuberance and herding in financial markets," SFB 649 Discussion Papers 2016-016, Humboldt University Berlin, Collaborative Research Center 649: Economic Risk.
    8. repec:hum:wpaper:sfb649dp2016-016 is not listed on IDEAS
    9. Loisel, O. & Pommeret, A. & Portier, T., 2012. "Monetary Policy and Herd Behavior: Leaning Against Bubbles," Working papers 412, Banque de France.
    10. Hong Liu & Jingyuan Wu & Qingshan Yang, 2017. "Inside Trading when the Market Deviates from the Semi-strong Efficient Condition," Annals of Economics and Finance, Society for AEF, vol. 18(1), pages 111-128, May.
    11. Jurkatis, Simon & Kremer, Stephanie & Nautz, Dieter, 2012. "Correlated trades and herd behavior in the stock market," SFB 649 Discussion Papers 2012-035, Humboldt University Berlin, Collaborative Research Center 649: Economic Risk.
    12. repec:hum:wpaper:sfb649dp2012-035 is not listed on IDEAS
    13. Irene Comeig & Ernesto Mesa-Vázquez & Pau Sendra-Pons & Amparo Urbano, 2020. "Rational Herding in Reward-Based Crowdfunding: An MTurk Experiment," Sustainability, MDPI, vol. 12(23), pages 1-21, November.
    14. repec:hum:wpaper:sfb649dp2013-036 is not listed on IDEAS
    15. Rüdiger, Jesper & Vigier, Adrien, 2019. "Learning about analysts," Journal of Economic Theory, Elsevier, vol. 180(C), pages 304-335.

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