Informational Herding, Optimal Experimentation, and Contrarianism

In the standard herding model, privately informed individuals sequentially see prior actions and then act. An identical action herd eventually starts and public beliefs tend to “cascade sets” where social learning stops. What behaviour is socially efficient when actions ignore informational externalities? We characterize the outcome that maximizes the discounted sum of utilities. Our four key findings are: (a) Cascade sets shrink but do not vanish, and herding should occur but less readily as greater weight is attached to posterity. (b) An optimal mechanism rewards individuals mimicked by their successor. (c) Cascades cannot start after period one under a signal logconcavity condition. (d) Given this condition, efficient behaviour is contrarian, leaning against the myopically more popular actions in every period. We make two technical contributions: As value functions with learning are not smooth, we use monotone comparative statics under uncertainty to deduce optimal dynamic behaviour.We also adapt dynamic pivot mechanisms to Bayesian learning.

Observational learning in large anonymous games

I present a model of observational learning with payoff interdependence. Agents, ordered in a sequence, receive private signals about an uncertain state of the world and sample previous actions. Unlike in standard models of observational learning, an agent's payoff depends both on the state and on the actions of others. Agents want both to learn the state and to anticipate others' play. As the sample of previous actions provides information on both dimensions, standard informational externalities are confounded with payoff externalities. I show that in spite of these confounding factors, when signals are of unbounded strength, there is learning in a strong sense: agents' actions are ex post optimal given both the state of the world and others' actions. With bounded signals, actions approach ex post optimality as the signal structure becomes more informative.

A NOTE ON CREDIT RISK TRANSFER AND THE MACROECONOMY

The recent financial crisis highlighted the limits of the originate to distribute model of banking, but its nexus with the macroeconomy remains unexplored. I build a business cycle model with banks engaging in credit risk transfer (CRT) under informational externalities. Markets for CRT provide liquidity insurance to banks, but the emergence of a pooling equilibrium can also impair the banks' monitoring incentives. In normal times and in face of standard macro shocks the insurance benefits of CRT prevail and the business cycle is stabilized. In face of financial/liquidity shocks the extent of informational asymmetries is larger and the business cycle is amplified. The macro model with CRT can also reproduce well a number of macro and banking statistics over the period of rapid growth of this banks' business model.

Agricultural price volatility and speculation by commodity index funds: a theoretical analysis

Purpose The role that speculation in futures markets plays during food price spikes is a subject of lively dispute. This issue is often addressed with empirical analyses. They suffer from data limitations and focus on the short-term impacts. The paper aims to discuss these issues. Design/methodology/approach The authors develop a theoretical model to explain the behaviour of speculators and producers in futures and cash markets. Compared to the only two theoretical analyses by Vercammen and Doroudian where informational externalities are excluded and by Fishe et al. where production responses are excluded, the authors introduce both informational externalities and lagged production responses. Findings The authors find that the expanded net long positions of commodity index funds (CIF) are inconsistent with lower stock levels that typically prevail before the price spikes. These positions stimulate production, hence stocks, before the price spikes. Thus they contribute to soften the price volatility. Practical implications The simulation results indicate that before imposing new regulations on financial markets, such as position limits on index funds, their beneficial medium-term effect as a hedging instrument for commercial participants should not be omitted or underestimated. Originality/value Because the authors develop a second-best theoretical framework, the authors find that CIF are not a systematic cause of medium-term market swings.