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

53 Pages Posted: 31 Mar 2007

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: February 2007

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 analyze 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.

Keywords: Informational Cascades, Herd Behavior, Trade Costs, Tobin Tax

JEL Classification: C92, D8, G14

Suggested Citation

Cipriani, Marco and Guarino, Antonio, Transaction Costs and Informational Cascades in Financial Markets: Theory and Experimental Evidence (February 2007). ECB Working Paper No. 736. Available at SSRN: https://ssrn.com/abstract=965422

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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