Financial Markets Where Traders Neglect the Informational Content of Prices

Financial Markets Where Traders Neglect the Informational Content of Prices

  • ERIK EYSTER
  • MATTHEW RABIN
  • DIMITRI VAYANOS

Article first published online: 8th October 2018 DOI: 10.1111/jofi.12729

Abstract


We model a financial market where some traders of a risky asset do not fully appreciate what prices convey about others' private information. Markets comprising solely such “cursed” traders generate more trade than those comprising solely rationals. Because rationals arbitrage away distortions caused by cursed traders, mixed markets can generate even more trade. Per‐trader volume in cursed markets increases with market size; volume may instead disappear when traders infer others' information from prices, even when they dismiss it as noisier than their own. Making private information public raises rational and “dismissive” volume, but reduces cursed volume given moderate noninformational trading motives.

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