Pierpaolo Benigno and Anastasios G. Karantounias
Working Paper 2017-14a
November 2017 (Revised June 2019)
JEL classification: D4, D8, E3
Key words: overconfidence, overprecision, imperfect common knowledge, information acquisition, inflation volatility
Download the full text of this paper 
We study the implications of overconfidence for price setting in a monopolistic competition setup with incomplete information. Our price-setters overestimate their abilities to infer aggregate shocks from private signals. The fraction of uninformed firms is endogenous; firms can obtain information by paying a fixed cost. We find two results: (1) overconfident firms are less inclined to acquire information, and (2) prices might exhibit excess volatility driven by nonfundamental noise. We explore the empirical predictions of our model for idiosyncratic price volatility.
The authors are grateful to the editor and three anonymous referees who helped us improve the paper. They especially thank Giuseppe Moscarini and Ricardo Reis for their discussions and Leonardo Melosi and Michael Woodford for comments. They also thank seminar participants at the Board of Governors of the Federal Reserve System, Columbia University, and New York University and to conference participants at the New York Area Monetary Policy Workshop. The views expressed here are those of the authors and not necessarily those of the Federal Reserve Bank of Atlanta or the Federal Reserve System. Any remaining errors are the authors' responsibility.
Please address questions regarding content to Pierpaolo Benigno, LUISS Guido Carli and Einaudi Institute of Economics and Finance, Viale Romania 32, 00197, Roma, Italy, pbenigno@luiss.it, or Anastasios G. Karantounias, Research Department, Federal Reserve Bank of Atlanta, 1000 Peachtree Street NE, Atlanta, GA 30309, United States, 404-498-8825, anastasios.karantounias@atl.frb.org.
Federal Reserve Bank of Atlanta working papers, including revised versions, are available on the Atlanta Fed's website at www.frbatlanta.org. Click "Publications" and then "Working Papers." To receive e-mail notifications about new papers, use Subscribe.