Traders' values and information typically consist of both private and common-value elements. In such environments, full allocative efficiency is impossible when the private rate of information substitution differs from the social rate (Jehiel and Moldovanu, 2001). We link this impossibility result to a failure of the efficient market hypothesis, which states that prices adequately reflect all available information (Fama, 1970, 1991). The intuition is that if prices were able to reveal all information then the common value would simply shift traders' private values by a known constant and full allocative efficiency would result. In a series of laboratory experiments we study price formation in markets with private and common values. Rational expectations, which form the basis for the efficient market hypothesis, predict that the introduction of common values has no adverse consequences for allocative and informational efficiency. In contrast, a "private" expectations model in which traders' optimal behavior depends on both their private and common-value information predicts that neither full allocative nor full informational efficiency is possible. We test these competing hypotheses and find that the introduction of common values lowers allocative efficiency by 28% on average, as predicted by the private expectations model, and that market prices differ significantly and substantially from their rational expectation levels. Finally, a comparison of observed and predicted payoffs suggests that observed behavior is close to the equilibrium predicted by the private expectations model.
|Date of creation:||May 2012|
|Contact details of provider:|| Postal: Schönberggasse 1, CH-8001 Zürich|
Phone: +41-1-634 21 37
Fax: +41-1-634 49 82
Web page: http://www.econ.uzh.ch/
More information through EDIRC
References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Plott, Charles R & Sunder, Shyam, 1982.
"Efficiency of Experimental Security Markets with Insider Information: An Application of Rational-Expectations Models,"
Journal of Political Economy,
University of Chicago Press, vol. 90(4), pages 663-698, August.
- Plott, Charles R. & Sunder, Shyam., "undated". "Efficiency of Experimental Security Markets with Insider Information: An Application of Rational Expectations Models," Working Papers 331, California Institute of Technology, Division of the Humanities and Social Sciences.
- Plott, Charles R & Sunder, Shyam, 1988. "Rational Expectations and the Aggregation of Diverse Information in Laboratory Security Markets," Econometrica, Econometric Society, vol. 56(5), pages 1085-1118, September.
- Plott, Charles R. & Sunder, Shyam., "undated". "Rational Expectations and the Aggregation of Diverse Information in Laboratory Security Markets," Working Papers 463, California Institute of Technology, Division of the Humanities and Social Sciences.
- Kjell G. Nyborg, 2004. "Multiple Unit Auctions and Short Squeezes," Review of Financial Studies, Society for Financial Studies, vol. 17(2), pages 545-580.
- Kjell G. Nyborg & Ilya A. Strebulaev, 2003. "Multiple Unit Auctions and Short Squeezes," Working Papers 2003.27, Fondazione Eni Enrico Mattei.
- Urs Fischbacher, 2007. "z-Tree: Zurich toolbox for ready-made economic experiments," Experimental Economics, Springer;Economic Science Association, vol. 10(2), pages 171-178, June.
- Smith, Vernon L., 2010. "Theory and experiment: What are the questions?," Journal of Economic Behavior & Organization, Elsevier, vol. 73(1), pages 3-15, January.
- Vernon L. Smith, 2009. "Theory and Experiment: What are the questions?," Post-Print hal-00673671, HAL.
- Friedman, Daniel, 2010. "Preferences, beliefs and equilibrium: What have experiments taught us?," Journal of Economic Behavior & Organization, Elsevier, vol. 73(1), pages 29-33, January. Full references (including those not matched with items on IDEAS)