Working Paper: CEPR ID: DP3080
Authors: Lluis Bru; Xavier Vives
Abstract: A version of the herding prediction model with a rational expectations flavor is reexamined in the light of incentive theory. The welfare loss at the market solution with respect to the incentive efficient solution can be decomposed into an information externality term minus an incentive cost term. It is found that the inefficiency of herding at the market solution is low when the cost of providing incentives is high. When the cost of providing incentives is low (and this happens when prior information is diffuse) the incentive efficient solution approaches the team solution that fully internalizes the information externality. Then the herding problem at the market solution is at its worst.
Keywords: Coordination; Information Aggregation; Mechanism Design; Rational Expectations; Teams
JEL Codes: D82; L13; L40
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| low incentive costs (J32) | increased herding inefficiency (C92) |
| high incentive costs (M52) | reduced herding inefficiency (C92) |
| cost of providing incentives (M52) | herding inefficiency (C92) |
| prior information diffusion (D83) | herding inefficiency (C92) |