The Social Cost of Near-Rational Investment

83 Pages Posted: 18 Mar 2008 Last revised: 31 Jul 2016

See all articles by Tarek A. Hassan

Tarek A. Hassan

Boston University; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

Thomas M. Mertens

Federal Reserve Bank of San Francisco

Multiple version iconThere are 3 versions of this paper

Date Written: July 30, 2016

Abstract

We show that the stock market may fail to aggregate information even if it appears to be efficient, and that the resulting decrease in the information content of prices may drastically reduce welfare. We solve a macroeconomic model in which information about fundamentals is dispersed and households make small, correlated errors when forming expectations about future productivity. As information aggregates in the market, these errors amplify and crowd out the information content of stock prices. When prices reflect less information, the conditional variance of stock returns rises, causing an increase in uncertainty and costly distortions in consumption, capital accumulation, and labor supply.

Keywords: Near-rationality, investment, capital accumulation

JEL Classification: E62, G11, O16

Suggested Citation

Hassan, Tarek Alexander and Mertens, Thomas M., The Social Cost of Near-Rational Investment (July 30, 2016). AFA 2012 Chicago Meetings Paper, Available at SSRN: https://ssrn.com/abstract=1106347 or http://dx.doi.org/10.2139/ssrn.1106347

Tarek Alexander Hassan (Contact Author)

Boston University ( email )

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Boston, MA 02215
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National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
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Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Thomas M. Mertens

Federal Reserve Bank of San Francisco ( email )

101 Market Street
San Francisco, CA 94105
United States

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