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The Social Cost of Near-Rational Investment

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

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

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 A. 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)

University of Chicago - Booth School of Business ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
United States

HOME PAGE: http://faculty.chicagobooth.edu/tarek.hassan/index.html

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Centre for Economic Policy Research (CEPR) ( email )

77 Bastwick Street
London, EC1V 3PZ
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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