Market Sentiment: A Tragedy of the Commons
Tarek A. Hassan
University of Chicago - Booth School of Business; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)
Thomas M. Mertens
Federal Reserve Bank of San Francisco
January 17, 2011
Fama-Miller Working Paper
Chicago Booth Research Paper No. 11-07
We present a model with dispersed information in which investors decide whether or to what degree they want to allow their behavior to be influenced by "market sentiment". Investors who choose to insulate their decision from market sentiment earn higher expected returns, but incur a small mental cost. We show that if information is moderately dispersed across investors, even a very small mental cost (on the order of 0.001% of consumption) may generate a significant amount of sentiment in equilibrium: Individuals who choose to be swayed by sentiment increase uncertainty about the future and make it less costly for others to be swayed by sentiment as well. Market sentiment thus emerges as a tragedy of the commons.
Number of Pages in PDF File: 6
Keywords: Noisy Rational Expectations, Sentiment, Dispersed Information
JEL Classification: D8, G11, G14
Date posted: December 19, 2010 ; Last revised: July 29, 2011
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