An equilibrium analysis of information aggregation and fluctuations in markets with discrete decisions. (Q1420878)

In a two period model of investment, the paper examines the equilibrium determination of aggregate investment and prices in a market where information is costly to acquire and individual investment decisions are discrete. In the first period, the investment market opens and there is a simultaneous determination of information acquisition decisions, the first period prices and investment decisions. In the second period, demand is realized, investors supply the market, second period price equilibrates the market and investor profits are realized. The model can generate (unique rational expectations) equilibrium randomness in that behaviour of aggregate investment may reflect the mass behaviour of uninformed investors rather than informed investors. This is not due to multiple equilibria but is akin to randomness involved in a equilibrating device in games allowing mixed strategies. Equilibrium can allow for large allocative errors, excessively high or low investment, even when agents gather information. Booms and busts arise endogenously in the model as a means of maintaining incentives to acquire information by providing occasional unpredictable periods of large errors which provide the opportunity of reaping the benefits of information gathering activities.