Informational price cascades and non-aggregation of asymmetric information in experimental asset markets

Shachat, Jason and Srivinasan, Anand (2011): Informational price cascades and non-aggregation of asymmetric information in experimental asset markets.

Abstract

We report on experimental markets for a contingent claim asset that eight subjects traded for nine periods before the state was revealed. There is an informative binary signal that arrives after each of the first eight trading rounds. In our baseline treatment the realization of the signal is public information, and in another treatment, market participants are randomly sequenced and receive the signal as private information. In the latter case, we observe zero information aggregation and prices lock in on home grown norms, which we call informational price cascades. We test the fragility of the price cascades in two further treatments. First, we break the monopoly on each signal by revealing it to two subjects, and then we increase that number to four. It is only when we inform four participants, or one-half of the market, that cascades fail to form and information starts to aggregate in the market.

• Item Type: MPRA Paper
• Language: English
• Keywords: Information cascade; information aggregation; experiment; asset market
• Subjects: G - Financial Economics > G1 - General Financial Markets > G12 - Asset Pricing ; Trading Volume ; Bond Interest Rates; C - Mathematical and Quantitative Methods > C9 - Design of Experiments > C92 - Laboratory, Group Behavior; D - Microeconomics > D8 - Information, Knowledge, and Uncertainty > D82 - Asymmetric and Private Information ; Mechanism Design

References

Alevy, Jonathan E., Michael S. Haigh, and John A. List. 2007. "Information Cascades: Evidence from a Field Experiment with Financial Market Professionals." Journal of Finance 62 (1):151

Anderson, Lisa and Charles A. Holt. 1997. "Information Cascades in the Laboratory." American Economic Review 87 (5):847-862.

Avery, Christopher and Peter Zemsky. 1998. "Multidimensional Uncertainty and Herd Behavior in Financial Markets." American Economic Review 88 (4):724-748.

Barner, Martin, Francesco Feri, and Charles R. Plott. 2006. "On the microstructure of price determination and information aggregation with sequential and asymmetric information arrival in an experimental asset market." Annals of Finance 1 (1):73-107.

Barrett, Garry F. and Stephen G. Donald. 2003. ”Consistent Tests for Stochastic Dominance." Econometrica 71 (1):71-104.

Bikhchandani, Sushil, David Hirshleifer, and Ivo Welch. 1992. "A Theory of Fads, Fashion, Custom, and Cultural Change as Informational Cascades." Journal of Political Economy 100 (5):992-1026.

Bloomeld, Robert, Maureen O'Hara, and Gideon Saar. 2009. "How Noise Trading A ects Markets: An Experimental Analysis." Review of Financial Studies 22 (6):2275-2302.

Bruguier, Antoine J., Steven R. Quartz, and Peter Bossaerts. 2010. "Exploring the Nature of 'Trader Intuition'." Journal of Finance 65 (5):1703-1723.

Caginalp, Gunduz, Li Hao, David Porter, and Vernon L. Smith. 2008. "Asset market reactions to news: an experimental study." Working papers, Chapman University, Economic Science Institute.

Camerer, Colin and Keith Weigelt. 1991. ”Information Mirages in Experimental Asset Markets." Journal of Business 64 (4):463-93.

Camerer, Colin F. 1987. ”Do Biases in Probability Judgment Matter in Markets? Experimental Evidence." American Economic Review 77 (5):981-97.

Celen, Bogachan and Shachar Kariv. 2004. ”Distinguishing Informational Cascades from Herd Behavior in the Laboratory." American Economic Review 94 (3):484 - 498.

Charness, Gary and Dan Levin. 2005. ”When Optimal Choices Feel Wrong: A Laboratory Study of Bayesian Updating, Complexity, and Affect." American Economic Review 95 (4):1300-1309.

Cipriani, Marco and Antonio Guarino. 2005. ”Herd Behavior in a Laboratory Financial Market." American Economic Review 95 (5):1427-1443. ¬¬¬¬ Copeland, Thomas E. and Daniel Friedman. 1987. ”The Effect of Sequential Information Arrival on Asset Prices: An Experimental Study." The Journal of Finance 42 (3):pp. 763-797.

Copeland, Thomas E. and Daniel Friedman. 1991. ”Partial Revelation of Information in Experimental Asset Markets." The Journal of Finance 46 (1):pp. 265-295.

Cox, James C. and J. Todd Swarthout. 2006. ”EconPort: Creating and Maintaining a Knowledge Commons." In Understanding Knowledge as a Commons: From Theory to Practice, edited by Charlotte Hess and Elinor Ostrom. MIT Press, 333-348.

Diamond, Douglas W. and Robert E. Verrecchia. 1981. ”Information aggregation in a noisy rational expectations economy." Journal of Financial Economics 9 (3):221-235.

Drehmann, Mathias, Joerg Oechssler, and Andreas Rider. 2005. ”Herding and Contrarian Behavior in Financial Markets: An Internet Experiment." American Economic Review 95 (5):1403-1426.

Dufwenberg, Martin, Tobias Lindqvist, and Evan Moore. 2005. ”Bubbles and Experience: An Experiment." American Economic Review 95 (5):1731-1737.

Forsythe, Robert and Russell Lundholm. 1990. ”Information Aggregation in an Experimental Market." Econometrica 58 (2):309-47.

Foster, F. Douglas and S Viswanathan. 1994. ”Strategic Trading with Asymmetrically Informed Traders and Long-Lived Information." Journal of Financial and Quantitative Analysis 29 (04):499-518.

Foster, F. Douglas and S. Viswanathan. 1996. ”Strategic Trading When Agents Forecast the Forecasts of Others." The Journal of Finance 51 (4):1437-1478.

Ganguly, Ananda R., John Kagel, and Donald V. Moser. 2000. ”Do Asset Market Prices Affect Traders' Judgment Biases?" Journal of Risk and Uncertainty 20 (3):219-45.

Gillete, Ann B., Douglas E. Stevens, Susan G. Watts, and Arlington W. Williams. 1999. “Price and Volume Reactions to Public Information Releases: An Experimental Approach Incorporating Traders' Subjective Beliefs*." Contemporary Accounting Research 16 (3):437-479.

Goeree, Jacob K., Thomas R. Palfrey, and Brian W. Rogers. 2007. ”Self-correcting Informational Cascades." The Review of Economic Studies 74:733-762.

Grether, David M. 1980. ”Bayes Rule as a Descriptive Model: The Representativeness Heuristic." The Quarterly Journal of Economics 95 (3):537-57.

Grossman, Sanford J. 1976. ”On the Efficiency of Competitive Stock Markets Where Traders Have Diverse Information." Journal of Finance 31 (2):573-85.

Haruvy, Ernan, Yaron Lahav, and Charles Noussair. 2007. ”Traders' Expectations in Asset Markets: Experimental Evidence." American Economic Review 97 (5):1901-1920.

Hayek, F. A. 1945. ”The Use of Knowledge in Society." The American Economic Review 35 (4):pp. 519-530.

Hey, John D. and Andrea Morone. 2004. ”Do Markets Drive Out Lemmings-or Vice Versa?" Economica 71 (284):637-659.

Hirota, Shinichi and Shyam Sunder. 2007. ”Price bubbles sans dividend anchors: Evidence from laboratory stock markets." Journal of Economic Dynamics and Control 31 (6):1875- 1909.

Hirshleifer, David. 2001. ”Investor Psychology and Asset Pricing." Journal of Finance 56 (4):1533-1597.

Holden, Craig W and Avanidhar Subrahmanyam. 1992. ”Long-Lived Private Information and Imperfect Competition." Journal of Finance 47 (1):247-70.

Holden, Craig W. and Avanidhar Subrahmanyam. 1994. ”Risk aversion, imperfect competition, and long-lived information." Economics Letters 44 (1-2):181-190.

Hurwicz, Leonid. 1972. ”On Informationally Decentralized Systems." In Decision and Organization: A Volume in Honor of Jacob Marschak, edited by C. B. McGuire and Roy Radner. Amsterdam: North-Holland.

Kubler, Dorothea and Georg Weizacker. 2004. ”Limited Depth of Reasoning and Failure of Cascade Formation in the Laboratory." The Review of Economics Studies 71 (2):425-441.

Kyle, Albert S. 1985. ”Continuous Auctions and Insider Trading." Econometrica 53 (6):1315-35.

Kyle, Albert S. 1989. ”Informed Speculation with Imperfect Competition." Review of Economic Studies 56 (3):317-55.

Lucas, Robert Jr. 1972. ”Expectations and the neutrality of money." Journal of Economic Theory 4 (2):103-124.

Milgrom, Paul and Nancy Stokey. 1982. ”Information, trade and common knowledge." Journal of Economic Theory 26 (1):17-27.

Park, Andreas and Daniel Sgroi. 2009. ”Herding, Contrarianism and Delay in Financial Market Trading." University or Warwick.

Plott, Charles R. and Shyam Sunder. 1982. ”Efficiency of Experimental Security Markets with Insider Information: An Application of Rational-Expectations Models." Journal of Political Economy 90 (4):663-98.

Plott, Charles R. and Shyam Sunder. 1988. ”Rational Expectations and the Aggregation of Diverse Information in Laboratory Security Markets." Econometrica 56 (5):1085-1118.

Porter, David and Vernon Smith. 2008. ”Price Bubbles." In Handbook of Experimental Economics Results, vol. 1, Part 1, edited by Charles R. Plott and Vernon L. Smith, chap. 30. Elsevier, 1 ed., 247-255.

Radner, Roy. 1979. ”Rational Expectations Equilibrium: Generic Existence and the Information Revealed by Prices." Econometrica 47 (3):655-78.

Sgroi, Danieal. 2003. ”The right choice at the right time: A herding experiment in endogenous time." Experimental Economics 6:159-180.

Smith, Vernon L. 1982. ”Microeconomic Systems as an Experimental Science." American Economic Review 72 (5):923-55.

Smith, Vernon L. 2010. ”Theory and experiment: What are the questions?" Journal of Economic Behavior & Organization 73 (1):3-15.

Smith, Vernon L., Gerry L. Suchanek, and Arlington W. Williams. 1988. ”Bubbles, Crashes, and Endogenous Expectations in Experimental Spot Asset Markets." Econometrica 56 (5):1119-51.

Smith, Vernon L., Mark van Boening, and Charissa P. Wellford. 2000. "Dividend timing and behavior in laboratory asset markets." Economic Theory 16:567-583.

Tirole, Jean. 1982. ”On the Possibility of Speculation under Rational Expectations." Econometrica 50 (5):1163-81.

Vives, Xavier. 1995. ”The Speed of Information Revelation in a Financial Market Mechanism." Journal of Economic Theory 67 (1):178-204.