Rational exuberance

We study a two-player investment game with information externalities. Necessary and sufficient conditions for a unique symmetric switching equilibrium are provided. When public news indicates that the investment opportunity is very profitable, too many types are investing early and investments should therefore be taxed. Conversely, any positive investment tax is suboptimally high if the public information is sufficiently unfavorable.

► We study a two-player investment game with information externalities in which investors are better informed than the policy maker. ► When public news indicates that the investment opportunity is very profitable, our model uniquely predicts rational exuberance, i.e. investors are too eager to invest early. ► As investors then learn little from observing each other, investments should be taxed.