Informational Externalities, Herding and Incentives

23 Pages Posted: 13 Dec 2001

See all articles by Lluis Bru

Lluis Bru

University of Malaga

Xavier Vives

University of Navarra - IESE Business School; Centre for Economic Policy Research (CEPR); CESifo (Center for Economic Studies and Ifo Institute for Economic Research)

Date Written: November 2001

Abstract

A version of the herding prediction model with a rational expectations flavor is reexamined in the light of incentive theory. The welfare loss at the market solution with respect to the incentive efficient solution can be decomposed into an information externality term minus an incentive cost term. It is found that the inefficiency of herding at the market solution is low when the cost of providing incentives is high. When the cost of providing incentives is low (and this happens when prior information is diffuse) the incentive efficient solution approaches the team solution that fully internalizes the information externality. Then the herding problem at the market solution is at its worst.

Keywords: Information aggregation, rational expectations, coordination, teams, mechanism design

JEL Classification: D82, L13, L40

Suggested Citation

Bru Martínez, Lluis and Vives, Xavier, Informational Externalities, Herding and Incentives (November 2001). Available at SSRN: https://ssrn.com/abstract=293628

Lluis Bru Martínez (Contact Author)

University of Malaga ( email )

Campus El Ejido Facultad de Ciencias Economicas y Empresariales
29013 Malaga
Spain
+34 952 1312 55 (Phone)
+34 952 1312 99 (Fax)

Xavier Vives

University of Navarra - IESE Business School ( email )

Avenida Pearson 21
Barcelona, 08034
Spain

HOME PAGE: http://wwwapp.iese.edu/faculty/facultyDetail.asp?lang=en&prof=xv

Centre for Economic Policy Research (CEPR)

London
United Kingdom

CESifo (Center for Economic Studies and Ifo Institute for Economic Research) ( email )

Poschinger Str. 5
Munich, DE-81679
Germany