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Transaction Costs and Informational Cascades in Financial Markets: Theory and Experimental Evidence

Author

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  • Marco Cipriani

    (George Washington University)

  • Antonio Guarino

    (University College London)

Abstract

We 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.

Suggested Citation

  • 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.
  • Handle: RePEc:wef:wpaper:0008
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    References listed on IDEAS

    as
    1. Marco Cipriani & Antonio Guarino, 2005. "Herd Behavior in a Laboratory Financial Market," American Economic Review, American Economic Association, vol. 95(5), pages 1427-1443, December.
    2. Avery, Christopher & Zemsky, Peter, 1998. "Multidimensional Uncertainty and Herd Behavior in Financial Markets," American Economic Review, American Economic Association, vol. 88(4), pages 724-748, September.
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    4. 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.
    5. Chamley,Christophe P., 2004. "Rational Herds," Cambridge Books, Cambridge University Press, number 9780521530927, June.
    6. Gale, Douglas, 1996. "What have we learned from social learning?," European Economic Review, Elsevier, vol. 40(3-5), pages 617-628, April.
    7. Chamley,Christophe P., 2004. "Rational Herds," Cambridge Books, Cambridge University Press, number 9780521824019, June.
    8. David Hirshleifer & Siew Hong Teoh, 2003. "Herd Behaviour and Cascading in Capital Markets: a Review and Synthesis," European Financial Management, European Financial Management Association, vol. 9(1), pages 25-66, March.
    9. Karl F Habermeier & Andrei A Kirilenko, 2001. "Securities Transaction Taxes and Financial Markets," IMF Working Papers 01/51, International Monetary Fund.
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    Cited by:

    1. Cipriani, Marco & Guarino, Antonio, 2008. "Transaction costs and informational cascades in financial markets," Journal of Economic Behavior & Organization, Elsevier, vol. 68(3-4), pages 581-592, December.
    2. Manganelli, Simone & Wolswijk, Guido, 2007. "Market discipline, financial integration and fiscal rules: what drives spreads in the euro area government bond market?," Working Paper Series 745, European Central Bank.
    3. Hirshleifer, David & Teoh, Siew Hong, 2008. "Thought and Behavior Contagion in Capital Markets," MPRA Paper 9164, University Library of Munich, Germany.
    4. J. Ford & D. Kelsey & W. Pang, 2013. "Information and ambiguity: herd and contrarian behaviour in financial markets," Theory and Decision, Springer, vol. 75(1), pages 1-15, July.
    5. Jesse Russell, 2012. "Herding and the shifting determinants of exchange rate regime choice," Applied Economics, Taylor & Francis Journals, vol. 44(32), pages 4187-4197, November.

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    More about this item

    JEL classification:

    • 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; Insider Trading

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