When Learning From Prices Leads to Mistakes

Economic agents can validate noise, leading to a feedback loop of overreaction

When you check the price of a stock or browse home listings in a new neighborhood, you’re seeing more than a number — you’re seeing a summary of what market participants collectively believe. Economists since Ludwig von Mises and Friedrich Hayek have celebrated this role: Prices aggregate dispersed private information and help guide economic activity. But what happens when the people making those decisions — firms, investors, households, even governments — shape the very same prices that they learn from?

My research reveals that this learning process can backfire, and it does so across a surprisingly wide range of markets. The core mechanism is a feedback loop: When economic agents extract information from prices, their resulting actions move the economy in ways that can validate noise in those prices, making small, nonfundamental disturbances look like real signals about the strength of the economy. A fleeting dip in interest rates leads firms to cut investment, which slows growth, which seems to confirm the pessimistic signal — even though the fundamentals never changed. A drop in borrowing costs in bond markets driven by dealer funding conditions may be misinterpreted as a sign of better investment opportunities, inducing overlending and overinvestment.

This same logic extends well beyond interest rates and bond prices. In commodity markets, producers who learn about global demand from futures prices can overreact to speculative trading, overproducing oil and leading to a buildup of inventories. In real estate, homebuyers and builders who gauge neighborhood quality from local house prices can chase noise-driven price spikes, inducing overbuilding, supply overhang, and the reshaping of neighborhoods in ways that might not reflect underlying fundamentals.

The feedback loop also creates a dilemma for policymakers. Governments face trade-offs when intervening in financial markets. For instance, trying to promote transparency in financial markets can compromise the informational role of prices and reduce market discipline. Fostering financial stability by intervening in asset markets can incentivize market participants to speculate on the scale of future interventions and crowd out fundamental information. In contexts such as China’s financial system or, more broadly, its industrial policy, the tension between guiding markets and preserving their informational value becomes especially acute.

Across all these settings, the through line is similar. The feature that makes prices so useful — their ability to aggregate information — can also make them fragile.

Brunnermeier, Markus, Michael Sockin, and Wei Xiong (2022), “China’s Model of Managing the Financial System,” The Review of Economic Studies 89, 6, 3115-3153. https://academic.oup.com/restud/article-abstract/89/6/3115/6484654

Gao, Zhenyu, Michael Sockin and Wei Xiong (2022), “Learning About the Neighborhood,”  The Review of Financial Studies 34, 9, 4323-4372. https://academic.oup.com/rfs/article-abstract/34/9/4323/6012372?redirectedFrom=fulltext

Sockin, Michael (2025), “Informational Frictions in Funding and Credit Markets,” Journal of Economic Theory 230, 106101. https://www.sciencedirect.com/science/article/abs/pii/S0022053125001474

Sockin, Michael and Wei Xiong (2015), “Informational Frictions and Commodity Markets,” The Journal of Finance 70, 5, 2063-2098. https://onlinelibrary.wiley.com/doi/abs/10.1111/jofi.12261