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Informational cascades with endogenous prices: The role of risk aversion

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  • Decamps, Jean-Paul
  • Lovo, Stefano

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
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  • Decamps, Jean-Paul & Lovo, Stefano, 2006. "Informational cascades with endogenous prices: The role of risk aversion," Journal of Mathematical Economics, Elsevier, vol. 42(1), pages 109-120, February.
    • Handle: RePEc:eee:mateco:v:42:y:2006:i:1:p:109-120
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    1. 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.
    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.
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    10. 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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