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Herd Behavior and Contagion in Financial Markets

Cipriani, M; Guarino, A; (2008) Herd Behavior and Contagion in Financial Markets. BE J THEOR ECON , 8 (1) , Article 24.

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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.

Type: Article
Title: Herd Behavior and Contagion in Financial Markets
Keywords: herd behavior, financial contagion, social learning, informational cascades, financial crises, INFORMATIONAL CASCADES, INTERNET EXPERIMENT, STOCK-PRICES, CRISES, MODEL, INVESTMENT, SPECIALIST, CONFUSION, IMPACT
UCL classification: UCL > Provost and Vice Provost Offices
UCL > Provost and Vice Provost Offices > UCL SLASH
UCL > Provost and Vice Provost Offices > UCL SLASH > Faculty of SandHS > Dept of Economics
URI: http://discovery.ucl.ac.uk/id/eprint/54698
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