Beauty contests and irrational exuberance
Subtitle: a neoclassical approach
By: [by] George-Marios Angeletos, Guido Lorenzoni [and] Alessandro Pavan
Contributors: Lorenzoni, Guido; Pavan, Alessandro; Massachusetts Institute of Technology. Dept. of Economics
Series: Working paper series / Massachusetts Institute of Technology, Dept. of Economics -- working paper 10-04; Working paper (Massachusetts Institute of Technology. Dept. of Economics) -- no. 10-04.
Publisher: Massachusetts Institute of Technology, Dept. of Economics
Published: 2010
Place of publication: Cambridge, MA
Language: eng
Number of pages: 47
Description: The arrival of new, unfamiliar, investment opportunities is often associated with "exuberant" movements in asset prices and real economic activity. During these episodes of high uncertainty, financial markets look at the real sector for signals about the profitability of the new investment opportunities, and vice versa. In this paper, we study how such information spillovers impact the incentives that agents face when making their real economic decisions. On the positive front, we find that the sensitivity of equilibrium outcomes to noise and to higher-order uncertainty is amplified, exacerbating the disconnect from fundamentals. On the normative front, we find that these effects are symptoms of constrained inefficiency; we then identify policies that can improve welfare without requiring the government to have any informational advantage vis-a-vis the market. At the heart of these results is a distortion that induces a conventional neoclassical economy to behave as a Keynesian "beauty contest" and to exhibit fluctuations that may look like "irrational exuberance" to an outside observer. Keywords: mispricing, heterogeneous information, information-driven complementarities, volatility, inefficiency, beauty contests. JEL Classifications: D82, E20, E44, G10, G14.
Notes: "March 5, 2010."

Includes bibliographical references (p. 43-47).

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