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

Lorenzo Esposito and Giuseppe Mastromatteo

Economics Working Paper Archive from Levy Economics Institute

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 (search for similar items in EconPapers)
JEL-codes: B15 E12 G01 G40 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-his, nep-hme, nep-hpe and nep-pke
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