When herding and contrarianism foster market efficiency: a financial trading experiment
Park, Andreas and Sgroi, Daniel (2008) When herding and contrarianism foster market efficiency: a financial trading experiment. Working Paper. Coventry: University of Warwick, Department of Economics. Warwick economic research papers (No.854).
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While herding has long been suspected to play a role in financial market booms and busts, theoretical analyses have struggled to identify conclusive causes for the effect. Recent theoretical work shows that informational herding is possible in a market with efficient asset prices if information is bi-polar, and contrarianism is possible with single-polar information. We present an experimental test for the validity of this theory, contrasting with all existing experiments where rational herding was theoretically impossible and subsequently not observed. Overall we observe that subjects generally behave according to theoretical predictions, yet the fit is lower for types who have the theoretical potential to herd. While herding is often not observed when predicted by theory, herding (sometimes irrational) does occur. Irrational contrarianism in particular leads observed prices to substantially differ from the efficient benchmark. Alternative models of behavior, such as risk aversion, loss aversion or error correction, either perform quite poorly or add little to our understanding.
|Item Type:||Working or Discussion Paper (Working Paper)|
|Subjects:||H Social Sciences > HG Finance
H Social Sciences > HB Economic Theory
|Divisions:||Faculty of Social Sciences > Economics|
|Library of Congress Subject Headings (LCSH):||Information theory in finance, Stock exchanges -- Research, Rational expectations (Economic theory), Endogenous growth (Economics), Stocks -- Prices -- Mathematical models|
|Series Name:||Warwick economic research papers|
|Publisher:||University of Warwick, Department of Economics|
|Place of Publication:||Coventry|
|Official Date:||29 April 2008|
|Number of Pages:||48|
|Institution:||University of Warwick|
|Status:||Not Peer Reviewed|
|Access rights to Published version:||Open Access|
|Funder:||Economic and Social Research Council (Great Britain) (ESRC), Social Sciences and Humanities Research Council of Canada (SSHRC), Cambridge Endowment for Research in Finance (CERF)|
Alevy, J. E., M. S. Haigh, and J. A. List (2007): “Information Cascades: Evidence from a Field Experiment with Financial Market Professionals,” Journal of Finance, LXII(1), 151–180.
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