The Role of Externalities and Information Aggregation in Market Collapse
Posted: 7 May 2009
Date Written: May 1, 2008
Abstract
We examine the role that belief, network externality, and information aggregation play in inefficient market collapses. After receiving consecutive negative shocks, some ex-ante identical Bayesian agents will be discouraged about the unknown state of the market they invest; therefore, they will stop investing. This decision will have two effects: first, it will cause agents to aggregate information through social/observational learning; second, it will decrease the network externality effect. We show that there might be an inefficient market collapse if the externality effect diminishes too much, and the cost of re-entry to the market is too high. We also analyze the effects of strategic delay and experimentation on the exit decision of the agents.
Keywords: Social (observational) learning, Information aggregation, Strategic delay (waiting), Experimentation, Coordination avalanche, Optimal stopping
JEL Classification: C72, D82
Suggested Citation: Suggested Citation