Experimental Economics Seminar - Jingjing Zhang (The University of Technology Sydney)
Title: Market Talk
Abstract: We study price formation and the role of cheap-talk communication in laboratory markets with private and common values. Rational expectations, which form the basis for the efficient market hypothesis, predict that the introduction of common values does not affect 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 allocative nor informational efficiency is possible. We test these competing hypotheses and find that the introduction of common values lowers allocative efficiency by 28%, as predicted by the private expectations model, and that market prices differ substantially from rational expectation levels.
Cheap-talk communication has a positive effect in reducing efficiency losses in bilateral settings with both private and common-values, but it has no effect or even a negative effect in larger, more competitive markets. The chat data can be classified according to a small number of communication protocols, which either reflect endogenously emerging institutions (negotiations, auctions, or posted prices), disclosure of private information, or inconsequential messages unrelated to trading (babbling). Truthful disclosure is stable in bilateral settings but breaks down in large groups with adverse effects for efficiency.