The "game" with information
Extreme market movements are often described as irrational and paraphrased with terms like panic or euphoria. In fact, however, it may well be rational motives that lead to such developments. If market participants have certain information, it is not only a matter of using it to their expected advantage - it must also be taken into account that other players may have anticipated them and the information may already have been priced in. It can therefore make sense to act early on, even if the information is still imprecise or uncertain.
A laboratory experiment
Laboratory experiments are important because in the real market it is difficult to observe or measure crucial parameters such as the timing and quality of private information. The model is based on the assumption that a certain amount of time is needed to collect or process good information about the value of an asset. All information that is priced in by other market participants in the meantime reduces the potential profit. Accordingly, there is a trade-off between acting quickly (Rush) and waiting for better information (Wait).
In his study, Chad Kendall therefore conducts the experiment with these two model variants:
Rush: The information is correct with a moderately high probability (75 percent) Rush is rational and, according to the theory, can be expected.
Wait: The information is correct with a hardly better probability than pure chance (54 percent). Here it is rational to wait until better information is available.
The laboratory experiment runs as follows:
A run is carried out over eight periods, whereby each of the eight participants only has to make exactly one trade
The start value is 0.5 and the end value after eight periods either 0 or 1
Additional private or public information is added over the periods until the result is certain in the eighth period
In order to examine learning effects and to shed light on the behavior of experienced market participants, a total of 30 runs are completed
The experiment will be conducted four times each for Rush and Wait (64 participants in total)
Participants must decide simultaneously in each period whether to trade or wait. Everyone must trade exactly once within the eight periods. In doing so, the participants can see the price development and the trades of the others (+1 for buy, -1 for sell). The price is calculated by the computer and continuously reflects both the publicly available information and the private information revealed by previous trades.