Herding Through Booms and Busts

Mathieu Taschereau-Dumouchel and Edouard Schaal

No 1166, Working Papers from Barcelona School of Economics

Abstract: This paper explores whether rational herding can generate endogenous aggregate fluctuations. We embed a tractable model of rational herding into a business cycle framework. In the model, technological innovations arrive with unknown qualities, and agents have dispersed information about how productive the technology really is. Rational investors decide whether to invest based on their private information and the investment behavior of others. Herd-driven boom-bust cycles arise endogenously in this environment when the technology is unproductive but investors' initial information is overly optimistic. Their overoptimism leads to high investment rates, which investors mistakenly attribute to good fundamentals, leading to a self-reinforcing pattern of higher optimism and higher investment until the economy reaches a peak, followed by a crash when agents ultimately realize their mistake. We calibrate the model to the U.S. economy and show that it can broadly explain boom-and-bust cycles like the dot-com bubble of the 1990s.

Keywords: imperfect information; endogenous business cycles; information cascade; social learning; boom-and-bust (search for similar items in EconPapers)
JEL-codes: D80 E32 (search for similar items in EconPapers)
Date: 2020-04
New Economics Papers: this item is included in nep-dge and nep-mac
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Related works:
Journal Article: Herding through booms and busts (2023)
Working Paper: Herding Through Booms and Busts (2021)
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Persistent link: https://EconPapers.repec.org/RePEc:bge:wpaper:1166

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