Learning in crowded markets

We study how competition among investors affects the efficiency of capital allocation, the speed of capital, and welfare. In our model, investors learn about other entrants in a fully flexible way. We find that competition increases the speed of capital, but does not necessarily improve the efficiency of capital allocation: there is persistent over- or underinvestment. As speed is a by-product of costly over-learning, increasing competition decreases welfare. We describe how the speed of capital and the level of over- or underinvestment depend on market and investor characteristics. With investors of heterogeneous skills, more sophisticated investors might harm welfare.