Information Acquisition, Efficiency, and Non-Fundamental Volatility

Information Acquisition, Efficiency, and Non-Fundamental Volatility

By Benjamin Hébert, Jennifer La'O
September 26,2019Working Paper No. 3836

This paper analyzes equilibria and efficiency in a class of economies (large games) that feature incomplete information, strategic interaction, and endogenous information acquisition, with beauty contests as a leading example. We adopt the rational inattention approach to endogenous information acquisition but generalize to a large class of information cost structures. Our framework allows agents to learn not only about exogenous states but also about endogenous aggregate actions. We study how the properties of the agents’ cost functions are related to the properties of equilibrium and efficient strategies in this class of games. First, we derive conditions under which equilibrium strategies may exhibit non-fundamental volatility; we show how this may be interpreted as a noisy public signal that arises endogenously within a rational inattention framework. Second, we derive a separate set of conditions under which equilibrium information acquisition is efficient. We find that inefficiency in information acquisition occurs when cost functions are such that agents endogenously choose to learn directly about the actions of other agents, as opposed to learning only about exogenous states. Mutual information, the cost function typically used in the rational inattention literature, precludes both non-fundamental volatility and imposes efficiency.

Keywords
information acquisition, Large Games, Rational Inattention