In the Long Run We Are All Herd: On the Nature and Outcomes of the Beauty Contest

35 Pages Posted: 17 Nov 2020

See all articles by Lorenzo Esposito

Lorenzo Esposito

Bank of Italy

Giuseppe Mastromatteo

Catholic University of the Sacred Heart of Milan

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Date Written: September 30, 2020

Abstract

Since the 2008 crisis, the economics literature has shown a renewed interest in Keynes’s “beauty contest” (BC) as a fundamental aspect of the functioning of financial markets. We argue that to understand the importance of the BC, psychological and informational factors are of small importance, and a dynamic-structural approach should be followed instead: the BC framework is paramount because it is rooted in the historical trajectory of capitalism and it is not simply a consequence of “irrational” (i.e., biased) agents. In this genuine form, the BC mechanism allows one to understand the main trends of a financialized world. Moreover, the conventional nature of financial markets provides a sound method for assessing different economic policies whose effectiveness depends on how much they can influence the convention itself. This alternative understanding of the BC can be used to start the needed rethinking of economics, urged by the crisis, that is for now reduced to studying the financial and psychological “imperfections” of the market.

Keywords: Financial Crisis; Financialization; Behavioral Economics; Herd Behavior; Convention

JEL Classification: B15; E12; G01; G40

Suggested Citation

Esposito, Lorenzo and Mastromatteo, Giuseppe, In the Long Run We Are All Herd: On the Nature and Outcomes of the Beauty Contest (September 30, 2020). Available at SSRN: https://ssrn.com/abstract=3702434 or http://dx.doi.org/10.2139/ssrn.3702434

Lorenzo Esposito (Contact Author)

Bank of Italy ( email )

Via Nazionale 91
Rome, 00184
Italy

Giuseppe Mastromatteo

Catholic University of the Sacred Heart of Milan ( email )

Largo Gemelli, 1
Via Necchi 9
Milan, MI 20123
Italy

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