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Risk attitude, beliefs updating and the information content of trades: an experiment

  • Lovo, Stefno

    ()

  • Bisière, Christophe

    ()

  • Décamps, Jean-Paul

    ()

In this paper, the authors conduct a series of experiments that simulate trading in financial markets and which allows them to identify the different effects that subjects’ risk attitudes and belief updating rules have on the information content of the order flow. They find that there are very few risk-neutral subjects and that subjects displaying risk aversion or risk-loving tend to ignore private information when their prior beliefs on the asset fundamentals are strong. Consequently, private information struggles penetrating trading prices. The authors find evidence of non-Bayesian belief updating (confirmation bias and under-confidence). This reduces (improves) market efficiency when subjects’ prior beliefs are weak (strong).

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Paper provided by HEC Paris in its series Les Cahiers de Recherche with number 917.

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Length: 33 pages
Date of creation: 19 May 2009
Date of revision:
Handle: RePEc:ebg:heccah:0917
Contact details of provider: Postal: HEC Paris, 78351 Jouy-en-Josas cedex, France
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  7. Alevy, Jonathan E. & Haigh, Michael S. & List, John A., 2003. "Information Cascades: Evidence From A Field Experiment With Financial Market Professionals," Working Papers 28608, University of Maryland, Department of Agricultural and Resource Economics.
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  12. Bikhchandani, Sushil & Hirshleifer, David & Welch, Ivo, 1992. "A Theory of Fads, Fashion, Custom, and Cultural Change in Informational Cascades," Journal of Political Economy, University of Chicago Press, vol. 100(5), pages 992-1026, October.
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  18. Huck, Steffen & Oechssler, Jorg, 2000. "Informational cascades in the laboratory: Do they occur for the right reasons?," Journal of Economic Psychology, Elsevier, vol. 21(6), pages 661-671, December.
  19. Hirshleifer, David & Teoh, Siew Hong, 2001. "Herd Behavior and Cascading in Capital Markets: A Review and Synthesis," MPRA Paper 5186, University Library of Munich, Germany.
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  22. Bogaçhan Çelen & Shachar Kariv, 2004. "Distinguishing Informational Cascades from Herd Behavior in the Laboratory," American Economic Review, American Economic Association, vol. 94(3), pages 484-498, June.
  23. Michael Kilka & Martin Weber, 2001. "What Determines the Shape of the Probability Weighting Function Under Uncertainty?," Management Science, INFORMS, vol. 47(12), pages 1712-1726, December.
  24. Decamps, Jean-Paul & Lovo, Stefano, 2006. "Informational cascades with endogenous prices: The role of risk aversion," Journal of Mathematical Economics, Elsevier, vol. 42(1), pages 109-120, February.
  25. Glosten, Lawrence R. & Milgrom, Paul R., 1985. "Bid, ask and transaction prices in a specialist market with heterogeneously informed traders," Journal of Financial Economics, Elsevier, vol. 14(1), pages 71-100, March.
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