Learning, Cascades and Transaction Costs

Abstract

This paper analyzes the effect of transaction costs on the social learning in an asset market with asymmetric information, sequential trading and competitive price mechanism. Both fixed and proportional transaction costs reduce the informational content of trading orders and lead to informational cascades. If transaction costs are very high, an informational cascade can occur not only when beliefs converge to a specific asset value, but also when in the market there is complete uncertainty about the asset's fundamental value. Finally, if the asset value in the bad state is sufficiently low, proportional transaction costs lead to an informational cascade only when prices are very high.