Informational cascades with endogenous prices: The role of risk aversion

J. Décamps, S. LOVO

Journal of Mathematical Economics

February 2006, vol. 42, n°1, pp.109-120

Departments: Finance, GREGHEC (CNRS)

In this paper, we show that long run market informational inefficiency and informational cascades can easily happen when trades occur at market clearing prices. We consider a sequential trade model where: (i) the investors' set of actions is discrete; (ii) dealers and investors differ in risk aversion; (iii) investors' information is bounded. We show that informational cascade occurs as soon as traders' beliefs do not differ too sharply. Thus, prices cannot fully incorporate the private information dispersed in the economyInformational cascades; Endogenous prices; Risk aversion