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Outline. In-Class Experiment on Security Markets with Insider Information Test of Rational Expectation Hypothesis I: Plott and Sunder (1982) Can market be used to disseminate information? (or does price reflect insider information?)

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Outline

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  1. Outline • In-Class Experiment on Security Markets with Insider Information • Test of Rational Expectation Hypothesis I: Plott and Sunder (1982) • Can market be used to disseminate information? (or does price reflect insider information?) • Test of Rational Expectation Hypothesis II: Plott and Sunder (1988) • Can market be used to aggregate diverse information? (or does price reflect aggregate information?) • Field Application at HP: Kay-Yut Chen, Senior Scientist, HP Lab

  2. Induced Preference

  3. Controls on Cash and Security Flow

  4. Type of Traders and Dividend Rate • Markets 1-3: Two types of trader (I and II) • Markets 4-6, 10-11: Three types of traders (I, II, and III) • Four traders in each type of traders • Markets 7-9: One type of traders but there are 12 of them • Initial endowment is 2 except in markets 5_S, 6-7, and 9-10, it is 4

  5. Design of Markets

  6. Asset Type

  7. Single Security vs. Contingent Claims • Single Security (e.g., Market 3) • A type II trader yielded a dividend of 230 if the state was X, 90 francs if the state was Y, and 60 francs if the state was Z. • Contingent Claims (e.g., Market 4) • The contingent claims markets had 3 different securities x, y, z. • Let’s focus on Type I trader. • The x securities yielded a positive dividend of 70 if x occurred and zero otherwise. • The y securities yielded a positive dividend of 130 if y occurred and zero otherwise. • The z securities yielded a positive dividend of 300 if z occurred and zero otherwise. • A portfolio of one of each type of security is equivalent to one security in the single security markets.

  8. Design of Markets

  9. Hypotheses • Rational Expectation (RE) Hypothesis (Null) • Traders behave as if they are aware of the pooled information of all traders in the system. That is, they behave as if they know the state with certainty • Prior-Information (PI) Hypothesis • Determine posterior probability • EV maximizers • Maximin (MM) Hypothesis • Determine posterior probability • Traders will not purchase unless the price is below the minimum they could possibly receive given their prior information

  10. Price and Allocation Predictions:RE vs. PI vs. MM

  11. Design of Markets

  12. Price and Allocation Predictions:RE vs. PI. vs. MM

  13. PI: Prices of Contingent Claims in Market 4

  14. Actual versus Predicted Prices at the last occurrence of each state

  15. Market 10: RE did not work well

  16. Market 1: RE did not work well

  17. Market 2: RE did not work well

  18. Market 4: RE Worked Well

  19. Market 8: RE Worked Well

  20. Market 9: RE Worked Well

  21. Security Transfer Measure

  22. Actual and Predicted Allocations at the End of Each Market

  23. Actual and Predicted Profit Distributions

  24. Efficiency

  25. Efficiency

  26. |Actual – Predicted Efficiency|

  27. Summary • Behaviors in Series A (single security with diverse preferences) are only partially captured by RE model (e.g., Market 10) • If the markets are complete (as in Series B) or is preferences are identical (Series C), the RE model provides a reasonably accurate description of behaviors (Market 4-CC, Markets 8 and 9).

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