Relative Wealth Concerns and Technology Bubbles
28 Pages Posted: 17 Feb 2005
Date Written: January 16, 2005
We develop a stylized general equilibrium model in which technology "bubbles" occur. In our model, agents are able to invest both in a riskless technology and in a risky one. A high risk/reward technology supports over-investment and risk-taking behavior at a rate which is increasing in its risk. When the returns to the risky technology are decreasing in its rate of adoption, we show that investors may over-invest to the point that the expected return of the investment is negative.
In our model, agents care only about their own consumption, but due to competition over some consumption goods, relative wealth considerations arise in equilibrium. Investors' indirect utility function exhibits 'Keeping Up with the Joneses' properties, which may be strong enough to induce herding. We argue that such considerations may explain why the introduction of a new risky technology results in over investment, and in risk-taking behavior which seems to deviate from a rational outcome. Agents over-invest out of the fear of being "left behind" when others are successful.
Keywords: Bubble, technology, relative wealth, Joneses, herding, over-investment
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