Overweighting of public information in financial markets: A lesson from the lab

Ruiz-Buforn, Alba and Camacho-Cuena, Eva and Morone, Andrea and Alfarano, Simone (2020): Overweighting of public information in financial markets: A lesson from the lab.

Abstract

We experimentally study the information aggregation process in a laboratory financial market when a public signal is released. The public disclosure crowds out information demand and reduces price informativeness. The latter effect is primarily caused by the overweighting of public information into prices. We are the first in providing evidence that strategic pricing concerns trigger the overweighting effect and the consequent market overreaction to public disclosures. From an economic policy perspective, we give support that, when deciding their communication strategy, the regulator can mitigate the market overreaction by properly setting the level of information transparency.

• Item Type: MPRA Paper
• Language: English
• Keywords: Experimental asset markets; public information; information acquisition; asymmetric information
• Subjects: 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; G - Financial Economics > G1 - General Financial Markets > G14 - Information and Market Efficiency ; Event Studies ; Insider Trading

References

Ackert, L. F., Church, B. K., and Zhang, P. (2002). Market behavior in the presence of divergent and imperfect private information: experimental evidence from Canada, China, and the United States. Journal of Economic Behavior & Organization, 47(4):435-450.

Ackert, L. F., Church, Bryan, K., and Gillette, A. B. (2004). Immediate disclosure or secrecy? the release of information in experimental asset markets. Financial Markets, Institutions & Instruments, 13(5):219-243.

Allen, F., Morris, S., and Shin, H. S. (2006). Beauty contests and iterated expectations in asset markets. Review of Financial Studies, 19(3):719-752.

Amador, M. and Weill, P.-O. (2010). Learning from prices: public communication and welfare. Journal of Political Economy, 118(5):866-907.

Angeletos, G.-M. and Pavan, A. (2004). Transparency of information and coordination in economies with investment complementarities. The American Economic Review, 94(2):91-98.

Angeletos, G.-M. and Pavan, A. (2007). Efficient use of information and social value of information. Econometrica, 75(4):1103-1142.

Angrisani, M., Guarino, A., Huck, S., and Larson, N. C. (2008). No-trade in the laboratory. The BE Journal of Theoretical Economics, 11(1).

Asparouhova, E., Bossaerts, P., and Yang, W. (2017). Costly information acquisition in decentralized markets: an experiment. SSRN Working Paper.

Bacchetta, P. and Van Wincoop, E. (2008). Higher order expectations in asset pricing. Journal of Money, Credit and Banking, 40(5):837-866.

Baeriswyl, R. and Cornand, C. (2014). Reducing overreaction to central banks’ disclosures: theory and experiment. Journal of the European Economic Association, 12(4):1087-1126.

Baeriswyl, R. and Cornand, C. (2016). The predominant role of signal precision in experimental beauty contests. The BE Journal of Theoretical Economics, 16(1):267-301.

Bank of England (2015). One bank research agenda. Discussion paper.

Blinder, A. S., Ehrmann, M., Fratzscher, M., De Haan, J., and Jansen, D.-J. (2008). Central bank communication and monetary policy: A survey of theory and evidence. Journal of Economic Literature, 46(4):910-45.

Bloomfield, R., O’Hara, M., and Saar, G. (2009). How noise trading affects markets: an experimental analysis. Review of Financial Studies, 22(6):2275-2302.

Camerer, C. and Weigelt, K. (1991). Information mirages in experimental asset markets. Journal of Business, 64:463-493.

Camerer, C. F., Ho, T.-H., and Chong, J.-K. (2004). A cognitive hierarchy model of games. The Quarterly Journal of Economics, 119(3):861-898.

Carrillo, J. D. and Palfrey, T. (2011). No trade. Games and Economic Behavior, 71(1):66-87.

Chaffee, E. C. (2010). The Dodd-Frank Wall Street reform and consumer protection act: A failed vision for increasing consumer protection and heightening corporate responsibility in international financial transactions. American University Law Review, 60:1431.

Colombo, L. and Femminis, G. (2008). The social value of public information with costly information acquisition. Economics Letters, 100(2):196-199.

Colombo, L., Femminis, G., and Pavan, A. (2014). Information acquisition and welfare. The Review of Economic Studies, 81(4):1438-1483.

Copeland, T. E. and Friedman, D. (1991). Partial revelation of information in experimental asset markets. Journal of Finance, 46:265-295.

Copeland, T. E. and Friedman, D. (1992). The market value of information: some experimental results. Journal of Business, 65:241-266.

Corgnet, B., Deck, C., DeSantis, M., and Porter, D. (2018). Information (non) aggregation in markets with costly signal acquisition. Journal of Economic Behavior & Organization, 154:286-320.

Cornand, C. and Heinemann, F. (2008). Optimal degree of public information dissemination. The Economic Journal, 118(528):718-742.

Cornand, C. and Heinemann, F. (2014a). Experiments on monetary policy and central banking. In Experiments in macroeconomics, pages 167-227. Emerald Group Publishing Limited.

Cornand, C. and Heinemann, F. (2014b). Measuring agents’ reaction to private and public information in games with strategic complementarities. Experimental Economics, 17(1):61-77.

Dale, D. J. and Morgan, J. (2012). Experiments on the social value of public information. Mimeo.

De Long, J. B., Shleifer, A., Summers, L. H., and Waldmann, R. J. (1990). Noise trader risk in financial markets. Journal of Political Economy, 98(4):703-738.

Deck, C., Lin, S., and Porter, D. (2013). Affecting policy by manipulating prediction markets: Experimental evidence. Journal of Economic Behavior & Organization, 85:48-62.

Deck, C. and Porter, D. (2013). Prediction markets in the laboratory. Journal of Economic Surveys, 27(3):589-603.

European Commission (2009). Proposal for a regulation of the European Parliament and of the Council amending Regulation (EC) no 1060/2009 on credit rating agencies. 1060.

Eyster, E. and Rabin, M. (2005). Cursed equilibrium. Econometrica, 73(5):1623-1672.

Eyster, E., Rabin, M., and Vayanos, D. (2019). Financial markets where traders neglect the informational content of prices. Journal of Finance, 74(1):371-399.

Fama, E. (1970). Efficient capital markets: a review of theory and empirical work. Journal of Finance, 25:383-417.

Fellner, G. and Theissen, E. (2014). Short sale constraints, divergence of opinion and asset prices: Evidence from the laboratory. Journal of Economic Behavior & Organization, 101:113-127.

Ferri, G. and Morone, A. (2014). The effect of rating agencies on herd behaviour. Journal of Economic Interaction and Coordination, 9(1):107-127.

Fischbacher, U. (2007). z-tree: Zurich toolbox for ready-made economic experiments. Experimental Economics, 10(2):171-178.

Goldstein, I. and Yang, L. (2017). Information disclosure in financial markets. Annual Review of Financial Economics, 9:101-125.

Goldstein, I. and Yang, L. (2019). Good disclosure, bad disclosure. Journal of Financial Economics, 131(1):118-138.

Grossman, S. J. and Stiglitz, J. E. (1980). On the impossibility of informationally efficient markets. The American Economic Review, 70:393-408.

Hakansson, N. H., Kunkel, J. G., and Ohlson, J. A. (1982). Sufficient and necessary conditions for information to have social value in pure exchange. The Journal of Finance, 37(5):1169-1181.

Halim, E., Riyanto, Y. E., and Roy, N. (2019). Costly information acquisition, social networks, and asset prices: Experimental evidence. Journal of Finance, 74(4):1975-2010.

Hayek, F. A. (1945). The use of knowledge in society. The American Economic Review, 35(4):519-530.

Hellwig, C. and Veldkamp, L. (2009). Knowing what others know: coordination motives in information acquisition. The Review of Economic Studies, 76(1):223-251.

Hey, J. D. and Morone, A. (2004). Do markets drive out lemmings or vice versa? Economica, 71:637-659.

Hirshleifer, J. (1971). The private and social value of information and the reward to incentive activity. The American Economic Review, 61:561-574.

Huber, J. (2007). J-shaped returns to timing advantage in access to information- experimental evidence and a tentative explanation. Journal of Economic Dynamics and Control, 31(8):2536-2572.

Huber, J., Angerer, M., and Kirchler, M. (2011). Experimental asset markets with endogenous choice of costly asymmetric information. Experimental Economics, 14(2):223-240.

Kool, C., Middeldorp, M., and Rosenkranz, S. (2011). Central bank transparency and the crowding out of private information in financial markets. Journal of Money, Credit and Banking, 43(4):765-774.

Middeldorp, M. H. and Rosenkranz, S. (2011). Central bank transparency and the crowding out of private information in an experimental asset market. FRB of New York Staff Report, (487). Morris, S. and Shin, H. S. (2002). Social value of public information. The American Economic Review, 92(5):1521-1534.

Morris, S. and Shin, H. S. (2005). Central bank transparency and the signal value of prices. Brookings Papers on Economic Activity, 2005(2):1-66.

Myatt, D. P. and Wallace, C. (2011). Endogenous information acquisition in coordination games. The Review of Economic Studies, 79(1):340-374.

Myatt, D. P. and Wallace, C. (2014). Central bank communication design in a Lucas-Phelps economy. Journal of Monetary Economics, 63:64-79.

Nagel, R. (1995). Unraveling in guessing games: An experimental study. The American Economic Review, 85(5):1313-1326.

Noussair, C. N. and Tucker, S. (2013). Experimental research on asset pricing. Journal of Economic Surveys, 27(3):554-569.

Nuzzo, S. and Morone, A. (2017). Asset markets in the lab: A literature review. Journal of Behavioral and Experimental Finance. Page, L. and Siemroth, C. (2017). An experimental analysis of information acquisition in prediction markets. Games and Economic Behavior, 101:354-378.

Page, L. and Siemroth, C. (November 10, 2019). How much information is incorporated in financial asset prices? Experimental Evidence. Available at SSRN: https://ssrn.com/abstract=3130307 or http://dx.doi.org/10.2139/ssrn.3130307

Plott, C. R. (2000). Markets as information gathering tools. Southern Economic Journal, pages 2-15.

Plott, C. R. and Sunder, S. (1988). Rational expectations and the aggregation of diverse information in laboratory security markets. Econometrica, 56:1085-1118.

Powell, O. and Shestakova, N. (2016). Experimental asset markets: a survey of recent developments. Journal of Behavioral and Experimental Finance, 12:14-22.

Shapiro, D., Shi, X., and Zillante, A. (2014). Level-k reasoning in a generalized beauty contest. Games and Economic Behavior, 86:308-329.

Sunder, S. (1992). Market for information: experimental evidence. Econometrica, 60:667-695.

Sunder, S. (1995). Handbook of Experimental Economics, chapter Experimental asset markets: a survey. NJ: Princeton University Press.

Svensson, L. E. O. (2006). Social value of public information: Comment: Morris and shin (2002) is actually pro-transparency, not con. The American Economic Review, 96(1):448-452.

Vives, X. (2014). On the possibility of informationally efficient markets. Journal of the European Economic Association, 12(5):1200-1239.