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Risk Attitude, Beliefs Updating, and the Information Content of Trades: An Experiment

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  • Christophe Bisière

    (Toulouse School of Economics (IAE, IDEI, CRM), Université Toulouse 1 Capitole, 31000 Toulouse, France)

  • Jean-Paul Décamps

    (Toulouse School of Economics (IDEI, CRM), Université Toulouse 1 Capitole, 31000 Toulouse, France)

  • Stefano Lovo

    (Finance Department, HEC Paris, and GREGHEC, 78351 Jouy en Josas, France)

Abstract

We conduct a series of experiments that simulate trading in financial markets. We find that the information content of the order flow varies with the strength of subjects' prior beliefs about fundamentals. The presence of intrinsic uncertainty about the asset's fundamentals reduces informational efficiency. This originates from subjects' risk attitudes and biases in the way some subjects update their beliefs. The behavior of approximately 63% of the subjects is consistent with the expected utility maximization. These subjects are either risk averse (52%) or risk loving (11%). About 22% of the subjects display non-Bayesian updating of beliefs: underconfidence emerges for weak prior beliefs, and confirmation bias occurs for strong prior beliefs. Non-Bayesian belief updating reduces market efficiency when subjects' prior beliefs are weak and increases it when the prior beliefs are strong.Data, as supplemental material, are available at http://dx.doi.org/10.1287/mnsc.2013.1886 . This paper was accepted by Jerome Detemple, finance .

Suggested Citation

  • Christophe Bisière & Jean-Paul Décamps & Stefano Lovo, 2015. "Risk Attitude, Beliefs Updating, and the Information Content of Trades: An Experiment," Management Science, INFORMS, vol. 61(6), pages 1378-1397, June.
    • Handle: RePEc:inm:ormnsc:v:61:y:2015:i:6:p:1378-1397
    DOI: 10.1287/mnsc.2013.1886
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    More about this item

    Keywords

    behavior under uncertainty; risk attitude; belief updating; financial market efficiency; laboratory experiment;
    All these keywords.

    JEL classification:

    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design

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