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Two-Sided Learning and the Ratchet Principle

Gonzalo Cisternas

Review of Economic Studies, 2018, vol. 85, issue 1, 307-351

Abstract: I study a class of continuous-time games of learning and imperfect monitoring. A long-run player and a market share a common prior about the initial value of a Gaussian hidden state, and learn about its subsequent values by observing a noisy public signal. The long-run player can nevertheless control the evolution of this signal, and thus affect the market’s belief. The public signal has an additive structure, and noise is Brownian. I derive conditions for an ordinary differential equation to characterize equilibrium behavior in which the long-run player’s actions depend on the history of the game only through the market’s correct belief. Using these conditions, I demonstrate the existence of pure-strategy equilibria in Markov strategies for settings in which the long-run player’s flow utility is nonlinear. The central finding is a learning-driven ratchet principle affecting incentives. I illustrate the economic implications of this principle in applications to monetary policy, earnings management, and career concerns.

Keywords: Learning; Private beliefs; Ratchet effect; Brownian motion (search for similar items in EconPapers)
JEL-codes: C73 D82 D83 (search for similar items in EconPapers)
Date: 2018
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