Working Paper: CEPR ID: DP5219
Authors: Ivan Pastine; Tuvana Pastine
Abstract: In an observational learning environment, rational agents with incomplete information may mimic the actions of their predecessors even when their own signal suggests the opposite. This herding behaviour may lead the society to an inefficient outcome if the signals of the early movers happen to be incorrect. This paper analyses the effect of signal accuracy on the probability of an inefficient informational cascade. The literature so far has suggested that an increase in signal accuracy leads to a decline in the probability of inefficient herding, because the first movers are more likely to make the correct choice. Indeed, the simulation results in Bikhchandani, Hirshleifer and Welch (1992) support this proposition. This paper however shows this not to be the case in general. We present simulations that demonstrate that even a small departure from symmetry in signal accuracy may lead to non-monotonic results. An increase in signal accuracy may result in a higher likelihood of an inefficient cascade.
Keywords: Herding; Social Learning
JEL Codes: D80; D82
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| signal accuracy (C52) | probability of inefficient herding (C92) |
| asymmetric signal accuracy (C22) | probability of inefficient herding (C92) |
| signal accuracy of good candidate > signal accuracy of bad candidate (C52) | probability of misallocation (D61) |
| signal accuracy (C52) | agents' decisions to herd (C92) |
| agents' decisions to herd (C92) | market outcomes (P42) |