Information Mirages and Financial Contagion in Asset Market Experiment

We study financial contagion in an experimental market. There are two assets and an exogenous shock reduces the value of one of the two assets. Whether and how the other asset is affected depends on the correlation between the underlying values of the two assets. In some trials, the correlational relationship between the assets is unknown to all agents. In other trials, 50% of the traders are insiders who know the nature of the relationship between the assets. In periods with insiders, prices typically reveal private information. In periods without insiders, information mirages frequently occur, and can readily be interpreted as financial contagion that is unjustified by any underlying
fundamental relationship. Our results suggest that under asymmetric information, traders may overreact to data from one market with their behavior in other markets.