Paper #144

Title:

Shared knowledge

Author:

José V. Rodríguez Mora

Date:

September 1995

Abstract:

Agents use their knowledge on the history of the economy in order to choose what is the optimal action to take at any given moment of time, but each individual observes history with some noise. This paper shows that the amount of information available on the past evolution of the economy is an endogenous variable, and that this leads to overconcentration of the investment, which can be interpreted as underinvestment in research. It presents a model in which agents have to invest at each period in one of $K$ sectors, each of them paying an exogenous return that follows a well defined stochastic path. At any moment of time each agent receives an unbiased noisy signal on the payoff of each sector. The signals differ across agents, but all of them have the same variance, which depends on the aggregate investment in that particular sector (so that if almost everybody invests in it the perceptions of everybody will be very accurate, but if almost nobody does the perceptions of everybody will be very noisy). The degree of hetereogeneity across agents is then an endogenous variable, evolving across time determining, and being determined by, the amount of information disclosed. As long as both the level of social interaction and the underlying precision of the observations are relatively large agents behave in a very precise way. This behavior is unmodified for a huge range of informational parameters, and it is characterized by an excessive concentration of the investment in a few sectors. Additionally the model shows that generalized improvements in the quality of the information that each agent gets may lead to a worse outcome for all the agents due to the overconcentration of the investment that this produces.

Area of Research:

Macroeconomics and International Economics

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