Cipriani, M.; Guarino, A.; (2002) Herding and price convergence in a laboratory financial market. (ELSE Working Papers 71). ESRC Centre for Economic Learning and Social Evolution: London, UK.

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Abstract

We study whether herding can arise in a laboratory financial market in which agents trade sequentially. Agents trade an asset whose value is unknown and whose price is efficiently set by a market maker. We show that the presence of a price mechanism destroys the possibility of herding. Most agents follow their private information and prices converge to the fundamental value. This result contrasts with the case of a fixed price, where herding and cascades arise. When the price moves, however, agents may behave as contrarian, i.e., they may trade against the market, something not accounted for by the theory. Finally, we study whether informational cascades arise when trade is costly (e.g, because of a Tobin tax). With trade costs, most subjects rationally decided not to trade and the price was unable to aggregate private information efficiently.

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