Transaction Costs and Informational Cascades in Financial Markets: Theory and Experimental Evidence

World Economy & Finance Research Programme Working Paper No. 0008

38 Pages Posted: 1 Nov 2006

See all articles by Marco Cipriani

Marco Cipriani

Federal Reserve Bank of New York

Antonio Guarino

University College London - Centre for Economic Learning and Social Evolution (ELSE)

Multiple version iconThere are 2 versions of this paper

Date Written: March 2006

Abstract

We study the effect of transaction costs (e.g. a trading fee or a transaction tax, like the Tobin tax) on the aggregation of private information in financial markets. We analyse a financial market à la Glosten and Milgrom, in which informed and uninformed traders trade in sequence with a market maker. Traders have to pay a cost in order to trade. We show that, eventually, all informed traders decide not to trade, independently of their private information, i.e. an informational cascade occurs. We replicated our financial market in the laboratory. We found that, in the experiment, informational cascades occur when the theory suggests they should. Nevertheless, the ability of the price to aggregate private information is not significantly affected.

JEL Classification: C92, D80, G14, M41

Suggested Citation

Cipriani, Marco and Guarino, Antonio, Transaction Costs and Informational Cascades in Financial Markets: Theory and Experimental Evidence (March 2006). World Economy & Finance Research Programme Working Paper No. 0008. Available at SSRN: https://ssrn.com/abstract=941163 or http://dx.doi.org/10.2139/ssrn.941163

Marco Cipriani (Contact Author)

Federal Reserve Bank of New York ( email )

33 Liberty Street
New York, NY 10045
United States

Antonio Guarino

University College London - Centre for Economic Learning and Social Evolution (ELSE) ( email )

Gower Street
London WC1E 6BT
United Kingdom

HOME PAGE: http://www.homepages.ucl.ac.uk/~uctpagu/

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