Revisiting Information Aggregation in Asset Markets: Reflective Learning & Market Efficiency

The ability of markets to aggregate disperse information leading to prices that reflect the fundamental value of an asset is key to assessing the often-debated efficiency of markets. We study information aggregation in the experimental environment originally created by Plott and Sunder (1988). Contrary to the current belief, we find that markets do not aggregate information. The model that best describes our data, as well as data on information aggregation subsequent to Plott and Sunder (1988), is prior information (Lintner, 1969). That is, traders use their private information but fail to use market prices to infer other traders’ information. We argue that reflecting on asset prices to infer others’ information requires specific skills related to the concept of cognitive reflection. We develop a learning model in which only a subset of the traders possess this reflective capacity. We show, using both simulations and laboratory experiments, that information aggregation can only be achieved when the market is populated by highly reflective traders and this high level of cognitive reflection is commonly known to all of the traders.