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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?)

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Outline
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
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 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
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
















Efficiency each state


Efficiency each state



Summary
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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