The Social Cost of Near-Rational Investment

Tarek Hassan and Thomas M. Mertens

No 10007, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: We show that the stock market may fail to aggregate information even if it appears to be efficient and that the resulting decrease in the information content of stock prices may drastically reduce welfare. We solve a macroeconomic model in which information about fundamentals is dispersed and households make small, correlated errors when forming expectations about future productivity. As information aggregates in the market, these errors amplify and crowd out the information content of stock prices. When stock prices reflect less information, the conditional variance of stock returns rises. This increase in financial risk distorts the long-run level of capital accumulation, and causes costly (first-order) distortions in the long-run level of consumption.

Keywords: Dispersed information; Information aggregation; Information externality; Stock market dysfunctionality (search for similar items in EconPapers)
JEL-codes: D83 E2 E3 G1 (search for similar items in EconPapers)
Date: 2014-06
New Economics Papers: this item is included in nep-mac
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Citations: View citations in EconPapers (6)

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Related works:
Journal Article: The Social Cost of Near-Rational Investment (2017)
Working Paper: The Social Cost of Near-Rational Investment (2016)
Working Paper: The Social Cost of Near-Rational Investment (2011)
Working Paper: The Social Cost of Near-Rational Investment (2010)
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