Herding Through Booms and Busts

64 Pages Posted: 19 Jul 2021

See all articles by Edouard Schaal

Edouard Schaal

CREI and Universitat Pompeu Fabra

Mathieu Taschereau-Dumouchel

Cornell University - Department of Economics

Multiple version iconThere are 2 versions of this paper

Date Written: July 15, 2021

Abstract

This paper explores whether rational herding can generate endogenous aggregate fluctuations. We embed a tractable model of rational herding into a business cycle framework. In the model, technological innovations arrive with unknown qualities and agents have dispersed information about how productive the technology really is. Rational investors decide whether to invest based on their private information and the investment behavior of others. Herd-driven boom-bust cycles arise endogenously in this environment when the technology is unproductive but investors' initial information is unusually optimistic. Their overoptimism leads to high investment rates, which investors mistakenly attribute to good fundamentals, leading to a self-reinforcing pattern of higher optimism and higher investment until the economy reaches a peak, followed by a crash when agents ultimately realize their mistake. We calibrate the model to the U.S. economy and show that it can explain boom-and-bust cycles in line with episodes like the dot-com bubble of the 1990s.

Keywords: herding, business cycles, boom and bust, dispersed information

JEL Classification: E32, D80

Suggested Citation

Schaal, Edouard and Taschereau-Dumouchel, Mathieu, Herding Through Booms and Busts (July 15, 2021). Available at SSRN: https://ssrn.com/abstract=3887718 or http://dx.doi.org/10.2139/ssrn.3887718

Edouard Schaal

CREI and Universitat Pompeu Fabra ( email )

Mathieu Taschereau-Dumouchel (Contact Author)

Cornell University - Department of Economics ( email )

414 Uris Hall
Ithaca, NY 14853-7601
United States

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
45
Abstract Views
228
PlumX Metrics