The Social Cost of Near-Rational Investment
American Economic Review
vol. 107,
no. 4, April 2017
(pp. 1059-1103)
Abstract
We show that the stock market may fail to aggregate information even if it appears to be efficient, and that the resulting decrease in the information content of prices may drastically reduce welfare. We solve a macroeconomic model in which information about fundamentals is dispersed and households make small, correlated errors when forming expectations about future productivity. As information aggregates in the market, these errors amplify and crowd out the information content of stock prices. When prices reflect less information, the conditional variance of stock returns rises, causing an increase in uncertainty and costly distortions in consumption, capital accumulation, and labor supply.Citation
Hassan, Tarek A., and Thomas M. Mertens. 2017. "The Social Cost of Near-Rational Investment." American Economic Review, 107 (4): 1059-1103. DOI: 10.1257/aer.20110433Additional Materials
JEL Classification
- D14 Household Saving; Personal Finance
- D83 Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
- D84 Expectations; Speculations
- E21 Macroeconomics: Consumption; Saving; Wealth
- E22 Investment; Capital; Intangible Capital; Capacity
- E24 Employment; Unemployment; Wages; Intergenerational Income Distribution; Aggregate Human Capital; Aggregate Labor Productivity
- G14 Information and Market Efficiency; Event Studies; Insider Trading