How Do Market Prices and Cheap Talk Affect Coordination?

Abstract

In many scenarios such as banking and liquidity crises, inefficiencies often arise because investors face uncertainties about economic fundamentals and the strategies of other investors. How information affects fundamental uncertainty is well studied, but how information affects strategic uncertainty is underexplored. This paper examines how two communication mechanisms, market and cheap talk, affect investment decisions and efficiency in an experimental investment game with both fundamental and strategic uncertainty. I find that market does not improve coordination because the expectation that coordination failures will occur is self-fulfilling, while cheap talk improves coordination because the signals of willingness to invest alleviate strategic uncertainty.

Keywords: coordination game, global game, cheap talk, asset market, experimental economics, fundamental uncertainty, strategic uncertainty, insolvency, illiquidity

JEL Classification: C7, C9, D8