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- Title
Rational Herding and Financial Fragility : Lessons for the Indian Banking System.
- Authors
Pal, Malabika
- Abstract
One of the most pervasive of human desires is to imitate others. Although innumerable everyday situations exist, emulation is particularly prominent in the financial realm. As illustrated by Keynes in his famous "beauty contest" example where he drew an analogy between professional investment and those newspaper competitions in which each competitor has to pick, not those which he himself finds prettiest, but those which he thinks the other competitors would like. "Herd behaviour" specifically refers to the phenomenon of everyone doing what everyone else is doing, even though their private information would suggest otherwise. Resource constraints often make it rational to free-ride on the private information of others. A negative information externality arises because each person's decision becomes less responsive to his own information. Inefficient information aggregation would result in market failure. This paper analyses the theoretical justifications that have been given in the literature on herding. It highlights the more recent move in which herding has been seen as a rational response as opposed to the conventional thinking which took such behaviour as representing deviations from rationality. Important lessons emerge for the Indian banking system as we trace the theoretical literature on the issue and global experience of financial fragility and crises causes by herding.
- Subjects
KEYNES, John Maynard, 1883-1946; BEAUTY contests; MARKET failure; FINANCIAL crises
- Publication
Prajnān, 2020, Vol 49, Issue 1, p67
- ISSN
0970-8448
- Publication type
Article