When better forecasting abilities can be harmful – results from an experimental financial market (original) (raw)
Related papers
Can better forecasting abilities be harmful? Evidence from experimental asset markets
The question of how useful information in financial markets is has been discussed for decades and is still unresolved. In this paper we challenge the widely held belief that success and failure in the stock market can largely be attributed to the information underlying the trading decisions. We present a dynamic multi-period experimental financial market with asymmetrically informed traders whose information is based on future dividends. While the best informed traders can outperform the market, we find that information is not always useful, as average informed traders have significantly lower returns than the worst informed. JEL-classification: C91; D82; D83, G10 Keywords: Value of information, asymmetric information, experimental economics, information structure # Without useful suggestions from and discussions with several colleagues this paper would not have made it to this final version. We would especially like to thank Michael Hanke, Klaus Schredelseker, Matthias Sutter, and Florian Hauser for their helpful contributions. Financial support from the University of Innsbruck is gratefully acknowledged
Asset prices and informed traders’ abilities: Evidence from experimental asset markets
Accounting, Organizations and Society, 2004
This study reports the results of fifteen experimental asset markets designed to investigate the effects of forecasts on market prices, traders' abilities to assess asset value, and the link between the two. Across the fifteen markets, the authors investigate alternative forecast-generating processes. In some markets the process produces an unbiased estimate of asset value and in others a biased estimate. The processes generating the biased forecasts, though, are less variable than the process generating the unbiased forecast. The authors find that, in general, periodend asset price reflects private forecasts, regardless of the forecast-generating process. Subsequently, they investigate whether traders' abilities to use forecasts differ across the forecast-generating processes. The authors find that most are able to properly use unbiased forecasts. They refer to them as smart traders. By comparison, a significant proportion is unable to properly use biased forecasts (typically traders' adjustments for bias are insufficient). Linking market outcomes and traders' abilities, the authors find that asset price appears to properly reflect unbiased forecasts as long as the market includes at least two smart informed traders who have sufficient ability to influence market outcomes. To obtain a comparable result in markets with the biased forecast, at least three smart informed traders with sufficient ability to influence market outcomes are necessary.
Today information is generally considered the most valuable good in modern economies. Especially in financial markets information is often viewed as the only ingredient necessary to achieve above-average returns. However, empirical, theoretical and experimental work shows that the matter is not that simple. We develop an experimental setting to analyse how valuable forecasting ability is in financial markets. We find that knowledge about the future development of the profits of a company does no necessarily improve the performance of an agent in the market. Our experimental markets show similar behaviour to real markets in several very important aspects, namely volatility clustering, excess kurtosis, and the autocorrelation behaviour. This increases our confidence, that the one feature not observable in real markets - the relation between information level and return - looks similar to our results as well.
Forecasting Skills in Experimental Markets: Illusion or Reality?
SSRN Electronic Journal, 2020
Using experimental asset markets, we study the situation of a financial analyst who is trying to infer the fundamental value of an asset by observing the market's history. We find that such capacity requires both standard cognitive skills (IQ) as well as social and emotional skills. However, forecasters with high emotional skills tend to perform worse when market mispricing is high as they tend to give too much emphasis to the noisy signals from market data. By contrast, forecasters with high social skills perform especially well in markets with high levels of mispricing in which their skills could help them detect possible manipulation attempts. Finally, males outperform females in the forecasting task after controlling for a large number of relevant individual characteristics such as risk attitudes, cognitive skills, emotional intelligence, and personality traits.
Experimental asset markets with endogenous choice of costly asymmetric information
Experimental Economics, 2011
Asymmetric distribution of information, while omnipresent in real markets, is rarely considered in experimental financial markets. We present results from experiments where subjects endogenously choose between five information levels (four of them costly). We find that (i) uninformed traders earn the highest net returns, while average informed traders always perform worst even when information costs are not considered; (ii) over time traders
A methodological note on eliciting price forecasts in asset market experiments
2016
We investigate (a) whether eliciting future price forecasts influences market outcomes, and (b) whether differences in the way subjects are incentivized to submit ''accurate'' price forecasts influence the market outcomes as well as the forecasts submitted by subjects in an experimental asset market. We consider three treatments: one without forecast elicitation (NF) and two with forecast elicitations. In one of the latter treatments, subjects are paid based on both their performance of forecasting and trading (Bonus), while in the other, they are paid based only on one of the two that is chosen randomly at the end of the experiment (Unique). While we found no statistical differences in terms of mispricing, trading volumes, and trading behavior between NF and Unique treatments, there were some statistically significant differences between NF and Bonus treatments. Thus, if the aim is to avoid influencing the behavior of subjects and the market outcomes by eliciting pr...
Journal of Economic Dynamics and Control, 2018
In this study, we investigate (a) whether eliciting future price forecasts influences market outcomes and (b) whether differences in the way in which subjects are incentivized to submit "accurate" price forecasts influence market outcomes as well as the forecasts in an experimental asset market. We consider four treatments: one without forecast elicitation and three with forecast elicitation. In two of the treatments with forecast elicitation, subjects are paid based on their performance in both forecasting and trading, while in the other treatment with forecast elicitations, they are paid based on only one of those factors, which is chosen randomly at the end of the experiment. We found no significant effect of forecast elicitation on market outcomes in the latter case. Thus, to avoid influencing the behavior of subjects and market outcomes by eliciting price forecasts, paying subjects based on either forecasting or trading performance chosen randomly at the end of the experiment is better than paying them based on both. In addition, we consider forecast-only experiments: one in which subjects are rewarded based on the number of accurate forecasts and the other in which they are rewarded based on a quadratic scoring rule. We found no significant difference in terms of forecasting performance between the two.
The Effect of Forecast Bias on Market Behavior: Evidence from Experimental Asset Markets
: This paper reports the results of 15 experimental asset markets designed to investigate the effect of optimistic forecast bias on market behavior. Each market is organized as a double oral auction in which participants trade a single-period asset with uncertain value. Traders are informed of the asset value distribution and, prior to trading, given the opportunity to acquire a forecast of the asset's periodend value. The degree of forecast bias is manipulated across experimental sessions so that in some sessions the forecast contains a systematic, upward (low or high) bias. We conduct sessions with inexperienced and experienced traders. The results suggest that market prices are supportive of a full revelation unbiased price in the unbiased markets and the experienced, low-bias markets. The results from the low-bias markets indicate that as long as traders have sufficient experience with such forecasts, asset prices reflect the debiased forecasts. In contrast, we find no evide...
Asymmetric information and survival in financial markets
Economic Theory, 2005
In the evolutionary setting for a …nancial market developed by , we consider an in…nitely repeated version of a model à la with asymmetrically informed traders. Informed traders observe the realisation of a payo¤ relevant signal before making their portfolio decisions. Uninformed traders do not have direct access to this kind of information, but can partially infer it from market prices. As a counterpart for their privileged information, informed traders pay a per period cost. As a result, information acquisition triggers a trade-o¤ in our setting. We prove that, as long as information is costly, a strictly positive measure of uninformed traders will survive. This result contributes to the literature on noise trading. It suggests that Friedman (1953)'s argument against the importance of noise traders in the process of price determination is too simplistic. Traders whose beliefs are "wrong" according to the best available information, in fact, are not wiped out by market forces and do a¤ect asset prices in the long run.