Beauty Contests and Irrational Exuberance: A Neoclassical Approach / George-Marios Angeletos, Guido Lorenzoni, Alessandro Pavan.

Format:

Book

Author/Creator:

Angeletos, George-Marios.

Contributor:

National Bureau of Economic Research.

Lorenzoni, Guido.

Pavan, Alessandro.

Series:

Working Paper Series (National Bureau of Economic Research) no. w15883.

NBER working paper series no. w15883

Language:

English

Physical Description:

1 online resource: illustrations (black and white);

Other Title:

Beauty Contests and Irrational Exuberance

Place of Publication:

Cambridge, Mass. National Bureau of Economic Research 2010.

Summary:

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 investigate policies that can improve welfare in our model without any informational advantage on the government's part. 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.

Notes:

Print version record

April 2010.