The Social Cost of Near-Rational Investment

84 Pages Posted: 9 May 2011

See all articles by Tarek A. Hassan

Tarek A. Hassan

Boston University; 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: May 2011

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.

Suggested Citation

Hassan, Tarek Alexander and Mertens, Thomas M., The Social Cost of Near-Rational Investment (May 2011). NBER Working Paper No. w17027, Available at SSRN: https://ssrn.com/abstract=1833164

Tarek Alexander Hassan (Contact Author)

Boston University ( email )

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National Bureau of Economic Research (NBER) ( email )

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Centre for Economic Policy Research (CEPR) ( email )

London
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Thomas M. Mertens

Federal Reserve Bank of San Francisco ( email )

101 Market Street
San Francisco, CA 94105
United States

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