Follies subdued: Informational efficiency under adaptive expectations and confirmatory bias

Authored by Gani Aldashev, Timoteo Carletti, Simone Righi

Date Published: 2011-09

DOI: 10.1016/j.jebo.2011.03.001

Sponsors: No sponsors listed

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Model Documentation: Other Narrative Flow charts Mathematical description

Model Code URLs: Model code not found

Abstract

We study the informational efficiency of a market with a single traded asset. The price initially differs from the fundamental value, about which the agents have noisy private information (which is, on average, correct). A fraction of traders revise their price expectations in each period. The price at which the asset is traded is public information. The agents' expectations have an adaptive component and a social-interactions component with confirmatory bias. We show that, taken separately, each of the deviations from rationality worsens the informational efficiency of the market. However, when the two biases are combined, the degree of informational inefficiency of the market (measured as the deviation of the long-run market price from the fundamental value of the asset) can be non-monotonic both in the weight of the adaptive component and in the degree of confirmatory bias. For some ranges of parameters. two biases tend to mitigate each other's effect, thus increasing informational efficiency. (C) 2011 Elsevier B.V. All rights reserved.

Tags

Agent-based models Asset pricing Confirmatory bias Informational efficiency