Transaction costs and informational cascades in financial markets: Theory and experimental evidence
AbstractWe study the effect of transaction costs (e.g., a trading fee or a transaction tax, like the Tobin tax)on the aggregation of private information in financial markets. We analyze a financial market à la Glosten and Milgrom, in which informed and uninformed traders trade in sequence with a market maker. Traders have to pay a cost in order to trade. We show that, eventually, all informed traders decide not to trade, independently of their private information, i.e., an informational cascade occurs. We replicated our financial market in the laboratory. We found that, in the experiment, informational cascades occur when the theory suggests they should. Nevertheless, the ability of the price to aggregate private information is not significantly affected. JEL Classification: C92, D8, G14
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Bibliographic InfoPaper provided by European Central Bank in its series Working Paper Series with number 0736.
Date of creation: Mar 2007
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Other versions of this item:
- Marco Cipriani & Antonio Guarino, 2006. "Transaction Costs and Informational Cascades in Financial Markets: Theory and Experimental Evidence," WEF Working Papers 0008, ESRC World Economy and Finance Research Programme, Birkbeck, University of London.
- C92 - Mathematical and Quantitative Methods - - Design of Experiments - - - Laboratory, Group Behavior
- D8 - Microeconomics - - Information, Knowledge, and Uncertainty
- G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies
This paper has been announced in the following NEP Reports:
- NEP-ALL-2007-04-09 (All new papers)
- NEP-EXP-2007-04-09 (Experimental Economics)
- NEP-MST-2007-04-09 (Market Microstructure)
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