The social value of overreaction to information

Matteo Bizzarri and Daniele d'Arienzo
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Daniele d'Arienzo: Capital Fund Management and Nova Business School.

CSEF Working Papers from Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy

Abstract: We study the welfare effects of overreaction to information in the form of diagnostic expectations in markets with asymmetric information, and the effect of a simple intervention in the form of a tax or a subsidy. A large enough level of overreaction is always welfare-decreasing and can rationalize a tax on financial transactions. A small degree of overreaction to private information can both increase or decrease welfare. This is because there are two competing externalities: an information externality, due to the informational role of prices, and a pecuniary externality, due to the allocative role of prices. When the information externality prevails on the pecuniary externality, the loading on private information in agents' trades is too small compared to the welfare optimum: in this case, a small degree of overreaction is welfare-improving.

Keywords: Overreaction; Diagnostic Expectations; Non-Bayesian learning; Taxes on Financial Transactions; Asymmetric Information; Externalities. (search for similar items in EconPapers)
JEL-codes: D82 D83 D91 G14 H23 (search for similar items in EconPapers)
Date: 2023-11-02
New Economics Papers: this item is included in nep-pbe
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Related works:
Journal Article: The social value of overreaction to information (2024)
Working Paper: The social value of overreaction to information (2024)
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Persistent link: https://EconPapers.repec.org/RePEc:sef:csefwp:690

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