Rumours and Markets

Abstract

The paper presents a simple model to study the effects of rumours on markets. Agents in our economy communicate with their local neighbours which gives rise to the possible spread of a rumour. As the rumour affects beliefs of the agents the evolution of the rumour has a direct impact on market outcomes. Our results show that if the rumour dies out long-run equilibrium prices correspond to pre-rumour values. However, if the rumour stays present it produces a price run-up for the good that is positively targeted by the rumour. Price run-ups related to rumours have been observed in empirical studies by Rose (1951), Pound and Zeckhauser (1990) and Zivney et al. (1996). The present model provides an analytical foundation for this finding.

Keywords: Rumour, Market, Price run-up

JEL Classification: D11, D51