Information mirages and financial contagion in an asset market experiment

Charles Noussair, Yilong Xu

Research output: Contribution to journalArticleScientificpeer-review

Abstract

Purpose
– The purpose of this paper is to consider whether asymmetric information about correlations between assets can induce financial contagion. Contagion, unjustified by fundamentals, would arise if participants react in one market to uninformative trades in the other market that actually convey no relevant information. The authors also consider whether the market accurately disseminates insider information about fundamental value correlations when such information is indeed present.

Design/methodology/approach
– The authors employ experimental asset markets to answer the research questions. The experimental markets allow participants to simultaneously trade two assets for multiple rounds. In each round, a shock occurs, which either have an idiosyncratic effect on the shocked asset, or a systematic effect on both assets. Half of the time, there exist insiders who know the true nature of the shock and how it affects the value of the other asset. The other half of the time, no agent knows whether there is a correlation between the assets. In such cases, there is the potential for the appearance of information mirages. Uninformed traders, in either condition, do not know whether or not there exist insiders, but can try to infer this from the market activity they observe.

Findings
– The results of the experiment show that when inside information about the nature of the correlation between assets does exist, it is readily disseminated in the form of market prices. However, when there is no private information (PI), mirages are common, demonstrating that financial contagion can arise in the absence of any fundamental relationship between assets. An analysis of individual behavior suggests that some unprofitable decisions appear to be related to an aversion to complex distributions of lottery payoffs.

Originality/value
– The study focusses on one of the triggers of unjustified financial contagion, namely, asymmetric information. The authors have studied financial contagion in a controlled experimental setting where the authors can carefully control information, and specify the fundamental interdependence between assets traded in different markets.
LanguageEnglish
Pages1029-1055
JournalJournal of Economic Studies
Volume42
Issue number6
DOIs
StatePublished - 15 Dec 2015

Fingerprint

Asset markets
Assets
Financial contagion
Market experiments
Insider
Asymmetric information
Default correlation
Interdependence
Lottery
Traders
Experimental asset markets
Market activity
Experimental markets
Information control
Contagion
Experiment
Private information
Fundamental values
Market price
Trigger

Keywords

  • Asset market experiment
  • financial contagion
  • information mirage

Cite this

Noussair, Charles ; Xu, Yilong. / Information mirages and financial contagion in an asset market experiment. In: Journal of Economic Studies. 2015 ; Vol. 42, No. 6. pp. 1029-1055
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Information mirages and financial contagion in an asset market experiment. / Noussair, Charles; Xu, Yilong.

In: Journal of Economic Studies, Vol. 42, No. 6, 15.12.2015, p. 1029-1055.

Research output: Contribution to journalArticleScientificpeer-review

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