| Author/Presenter |
Andreas Park (University of Toronto) |
| Co-author |
Daniel Sgroi (University of Warwick) |
| Title |
When Herding and Contrarianism Foster Market Efficiency: A Financial Trading Experiment |
| Abstract |
The theory of informational herding suggests that rational agents will often disregard their own information if the actions of others suggest an opposite course of action. The scope for this to play a role in financial crises has long been considered muted by the role of efficient prices. Recently, Park and Sabourian (2006) provided theoretically precise behavioral predictions for when informational herding behavior should and should not arise. They did the same for so-called contrarian behavior (moving against one's signal and against the crowd). The informational conditions are that a signal recipient needs to consider extreme outcomes more likely than moderate ones (for contrarianism she needs to believe that moderate outcomes are more likely than extreme ones). In this paper we report our findings from experiments that replicate this theoretical model. Our setup contrasts the existing literature where the experiments were designed so that herding was theoretically impossible (and subsequently not observed). Compared to the theoretical predications, people behave rationally 75%, of the time. The fit is higher for non-herding types (82-86%), but the herding/contrarian candidates fare worse (61%). Yet we also find that herding candidates are more prone to irrational herding or contrarianism: while the fully rationally expected herds are not observed as often as predicted by theory (31%), herding candidates exhibit a stronger tendency to herd than non-herding candidates (26% of the possible cases compared to 6% and 16% for no-herding types). Alternative models (risk, loss aversion or error correction) perform either quite poorly or add little to our understanding. In summary, people who receive information that may be conflicting, weaker or "somewhere in the middle" will shift around with market forces and trade sometimes this way, sometimes the other. |
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