Inattention in Crowded Markets
Abstract:
We present a novel model of crowded markets and rational inattent ion. Our main application is a financial market where early entrants can bu y low (far from fundamentals) and sell high (close to fundamentals). Early entrants bid up the price for late entrants, while late entrants increase t he exit price for early entrants. The order when an investor learns the exi stence of this opportunity is her type. Before entry, the investor can also learn on about how many are already entered which determines the attractiv eness of the opportunity. However, such learning is costly. Our analysis em phasize two sources of inefficiency: the inefficiency of the entry decision (which can lead to crowding), and the inefficiency of the learning decisio n. Our model predicts under-entry in transparent markets, over-entry in opa que markets and over-learning in all types of markets. We show that sometim es more opaque markets provide higher welfare. We also show that as the pro portion of sophisticated traders is increasing in global markets, crowding might not increase. Also, welfare might be higher in a market with very few sophisticated investors, even if they do not eliminate arbitrage opportuni ties. Our results also provide a rational for the increasing popularity of exclusive, and opaque trading venues as black pools.
DTSTAMP:20260421T173454Z DTSTART:20141006T173000Z DTEND:20141006T190000Z SEQUENCE:0 TRANSP:OPAQUE END:VEVENT END:VCALENDAR