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## PowerPoint Slideshow about ' Outline' - caldwell-humphrey

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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?)

- 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

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

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.

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

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

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

Market 10: RE did not work well each state

Market 1: RE did not work well each state

Market 2: RE did not work well each state

Market 4: RE Worked Well each state

Market 8: RE Worked Well each state

Market 9: RE Worked Well each state

Security Transfer Measure each state

Actual and Predicted Profit Distributions each state

Efficiency each state

Efficiency each state

|Actual – Predicted Efficiency| each state

Summary each state

- 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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