Reading the Market? Expectation Coordination and Theory of Mind

Abstract

Does the ability to ‘read the market’ affect equilibrium formation in asset markets? To answer this question, we conducted pre-registered learning to forecast experiments with market groups composed of either subjects with high or low Theory of Mind (ToM) capabilities, elicited via the eye gaze test. On the aggregate level, we find the markets with the highest ToM capabilities to form a price bubble that is about 40% smaller and coordinates better at about 75% on the price forecasts, compared to the group with the lowest ToM capabilities. However, we fail to find a significant effect between those groups comparing price and expectation dynamics.

Keywords: Theory of Mind, Strategic Uncertainty, Asset Bubbles, Experimental Finance

JEL Classification: C92, G40, G17