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.
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Bibliographic InfoPaper provided by ESRC World Economy and Finance Research Programme, Birkbeck, University of London in its series WEF Working Papers with number 0008.
Date of creation: Mar 2006
Date of revision:
Other versions of this item:
- Cipriani, Marco & Guarino, Antonio, 2007. "Transaction costs and informational cascades in financial markets: Theory and experimental evidence," Working Paper Series 0736, European Central Bank.
- 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
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