Following the Actions of Others : The Simple Average of Strategies in a Rational Expectations Economy

We study a rational expectations equilibrium economy where agents learn from the actions of others by adopting the simple average of ex ante optimal strategies of their social network. When information is exogenous, large social networks benefit all agents if and only if agents are relatively homogeneous in terms of risk aversion. In contrast, a setting where both information acquisition and network formation are endogenous leads to small social networks in equilibrium. Both solitary action and large social networks are not stable as agents have an incentive to form, respectively disintegrate into, small social networks of just two or three agents. However, each agent would benefit if larger networks were imposed on the entire economy by a central agent. These results indicate that, in some settings, economies can benefit from greater transparency about actions. We further show that imposing large social networks on the economy reduces information acquisition, market efficiency, market liquidity, and trading volume, while increasing return volatility