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Learning, Cascades, and Transaction Costs

Maria Romano

Review of Finance, 2007, vol. 11, issue 3, 527-560

Abstract: The paper analyzes the effect of transaction costs on social learning in an asset market with asymmetric information, sequential trading, and a competitive price mechanism. Both fixed and proportional transaction costs reduce the information content of trading orders and lead to informational cascades. If transaction costs are very high, an informational cascade may occur not only when beliefs converge on a specific asset value but also when there is extreme uncertainty about the asset's fundamental value. Finally, if the value in the bad state is sufficiently low, proportional transaction costs lead to an informational cascade only when prices are very high. Copyright 2007, Oxford University Press.

Date: 2007
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Handle: RePEc:oup:revfin:v:11:y:2007:i:3:p:527-560