Discussion Paper Details

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Title: Informational Externalities, Herding and Incentives

Author(s): Lluís Bru and Xavier Vives

Publication Date: November 2001

Keyword(s): coordination, information aggregation, mechanism design, rational expectations and teams

Programme Area(s): Industrial Organization

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.

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Bibliographic Reference

Bru, L and Vives, X. 2001. 'Informational Externalities, Herding and Incentives'. London, Centre for Economic Policy Research.