Cheap Talk, Prices and Crises: An Experimental Study

Abstract

This paper studies the role of public information in multiple-agent coordination problems underlying a variety of economic scenarios such as banking and debt crises. The impact of information on coordination in such settings rests on the interplay between two types of uncertainty that agents face: fundamental and strategic uncertainty (i.e. uncertainty about others’ actions). In a controlled laboratory setting, I study the impact of two key sources of public information on coordination: market prices and cheap talk (i.e. non-binding promises). I find that although informationally efficient market prices reduce fundamental uncertainty, efficiency of coordination does not improve because strategic uncertainty intensifies. In contrast, costless nonbinding cheap talk significantly improves coordination as it reduces strategic uncertainty.

Keywords: coordination game, cheap talk, asset market, experimental economics

JEL Classification: C7, C9, D8