The Speed of Information Revelation and Eventual Price Quality in Markets with Insiders: Comparing Two Theories

Abstract

Two theoretical literatures, one using Bayesian Nash equilibrium, and the other using noisy rational expectations equilibrium, both provide a foundation for understanding how private information is impounded into asset prices, yet some of their predictions are conflicting. Here, we compare for the first time, the two theories using data from carefully controlled laboratory asset markets. In the dynamics, we find strong evidence for Bayesian Nash equilibrium theory, while final prices support predictions of the noisy rational expectations equilibrium theory. Finally, we document that price volatility increases when information is being impounded in prices.

Keywords: market microstruture, noisy rational expectations, experimental finance, Bayesian Nash equilibrium

JEL Classification: G12, G14, C92