Local Discouragement and Global Collapse - a Theory of Information Avalanches

Abstract

We study a dynamic coordination game with incomplete information in which players may either be active or inactive. All players initially possess the same information and begin by coordinating on a high level of activity. As the game progresses, agents have different experiences and update accordingly. At some point, agents with a sufficiently long string of bad experiences will decide that the game isn't worth playing and will become inactive. This prospect can cause a total spontaneous collapse of activity in the population at large through a phenomenon we call an information avalanche.

By definition, when an information avalanche occurs, it is part of a Pareto efficient equilibrium and, therefore, does not rely on sun spots or other exogenous coordinating mechanisms. We show that an information avalanche can occur at any point in the game, that its occurrence does not depend on the true state of nature, and that allowing players to exchange information may merely hasten the onset of an avalanche.

JEL Classification: D83