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Market Sentiment: A Tragedy of the Commons

6 Pages Posted: 19 Dec 2010 Last revised: 29 Jul 2011

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

Date Written: January 17, 2011

Abstract

We present a model with dispersed information in which investors decide whether or to what degree they want to allow their behavior to be influenced by "market sentiment". Investors who choose to insulate their decision from market sentiment earn higher expected returns, but incur a small mental cost. We show that if information is moderately dispersed across investors, even a very small mental cost (on the order of 0.001% of consumption) may generate a significant amount of sentiment in equilibrium: Individuals who choose to be swayed by sentiment increase uncertainty about the future and make it less costly for others to be swayed by sentiment as well. Market sentiment thus emerges as a tragedy of the commons.

Keywords: Noisy Rational Expectations, Sentiment, Dispersed Information

JEL Classification: D8, G11, G14

Suggested Citation

Hassan, Tarek A. and Mertens, Thomas M., Market Sentiment: A Tragedy of the Commons (January 17, 2011). Fama-Miller Working Paper; Chicago Booth Research Paper No. 11-07. Available at SSRN: https://ssrn.com/abstract=1728151 or http://dx.doi.org/10.2139/ssrn.1728151

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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