Herd Behavior and Contagion in Financial Markets

Marco Cipriani and Antonio Guarino

The B.E. Journal of Theoretical Economics, 2008, vol. 8, issue 1, 56

Abstract: We study a sequential trading financial market where there are gains from trade, that is, where informed traders have heterogeneous private values. We show that an informational cascade (i.e., a complete blockage of information) arises and prices fail to aggregate information dispersed among traders. During an informational cascade, all traders with the same preferences choose the same action, following the market (herding) or going against it (contrarianism). We also study financial contagion by extending our model to a two-asset economy. We show that informational cascades in one market can be generated by informational spillovers from the other. Such spillovers have pathological consequences, generating long-lasting misalignments between prices and fundamentals.

Keywords: herd behavior; financial contagion; social learning; informational cascades; financial crises (search for similar items in EconPapers)
Date: 2008
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Citations: View citations in EconPapers (89)

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Working Paper: Herd Behavior and Contagion in Financial Markets (2010)
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DOI: 10.2202/1935-1704.1390

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