A New Perspective on Social Learning

Home prices in the United States experienced unprecedented growth beginning in the late 1990s, followed by a dramatic downturn in 2006 which caused a global economic recession. Though market fundamentals such as low interest rates and easy mortgage terms boosted housing prices, the full magnitude of the housing bubble can only be reconciled with a social epidemic of optimism for real estate. From a policy perspective, a solid understanding of the idea of social contagion is therefore desirable. Existing economic models of social learning have contributed to this understanding by showing that in many situations the decisions of rational individuals tend to converge quickly and the conformist outcome is often wrong. We argue in this dissertation, however, that some of the conclusions reached by the rational view of social learning are unsound which limits its capacity to explain social epidemics. A thorough investigation of the learning foundations of rational herding enables us to develop an alternative theoretical framework which holds greater promise for explaining social epidemics. Chapter 1 re-examines the classic model of Bayesian rational social learning most commonly investigated in the literature. Previous studies have mainly focused on the long-run properties of the equilibrium outcome in relation with the support of the private belief distribution. From a welfare perspective, this focus on the long-run learning outcome is misplaced. To address this concern, we introduce new measures of uniformity and fragility which enable us to discuss the medium-run properties of the equilibrium outcome. We find that less uniform investment decisions lead to higher welfare levels of the equilibrium outcome but lower fragility of rational herds. Chapter 2, the core of the thesis, investigates the learning foundations of economic models of social learning. We pursue the prevalent idea in economics that rational play is the outcome of a dynamic process of adaptation. Our learning approach offers us the possibility to clarify when and why equilibrium is likely to capture observed regularities in the field. Contrary to the eductive justification for equilibrium, a learning-theoretic model must address the issue of individual and interactive knowledge before the adaptive process starts. We argue that knowledge about the private belief distribution is unlikely to be shared in most social learning contexts. Absent this mutual knowledge, we show that the long-run outcome of the adaptive process favors nonBayesian rational play. Chapter 3 introduces a simple extension to the rational model of social learning by assuming that players update their beliefs in a non-Bayesian way. We examine the properties of this generalized social learning model and show that it is able to capture the experimental regularities. Unlike standard models of rational social learning, our model predicts that as a herd evolves players tend to quickly become extremely confident about the appropriateness of the chosen action which is why the fragility of the social learning process vanishes over time. Both regularities seem to prevail in social epidemics.