Informational Herding and Optimal Experimentation

40 Pages Posted: 30 Jan 2006

See all articles by Lones Smith

Lones Smith

University of Wisconsin at Madison - Department of Economics

Peter Norman Sorensen

University of Copenhagen - Department of Economics

Date Written: January 2006

Abstract

We show that far from capturing a formally new phenomenon, informational herding is really a special case of single-person experimentation ­ and 'bad herds' the typical failure of complete learning. We then analyze the analogous team equilibrium, where individuals maximize the present discounted welfare of posterity. To do so, we generalize Gittins indices to our non-bandit learning problem, and thereby characterize when contrarian behaviour arises: (i) While herds are still constrained efficient, they arise for a strictly smaller belief set. (ii) A log-concave log-likelihood ratio density robustly ensures that individuals should lean more against their myopic preference for an action the more popular it becomes.

JEL Classification: D83

Suggested Citation

Smith, Lones and Sorensen, Peter Norman, Informational Herding and Optimal Experimentation (January 2006). MIT Department of Economics Working Paper No. 22, Cowles Foundation Discussion Paper No. 1552, Available at SSRN: https://ssrn.com/abstract=140073

Lones Smith (Contact Author)

University of Wisconsin at Madison - Department of Economics ( email )

1180 Observatory Drive
Madison, WI 53706-1393
United States
608-263-3871 (Phone)
608-262-2033 (Fax)

HOME PAGE: http://www.lonessmith.com

Peter Norman Sorensen

University of Copenhagen - Department of Economics ( email )

Oster Farimagsgade 5
Building 26
Copenhagen K, 1353
Denmark
+45 35 32 3056 (Phone)

HOME PAGE: http://www.econ.ku.dk/sorensen

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