HEC Research Papers Series,
HEC Paris

Abstract: In this paper, the authors conduct a series of experiments that simulate trading in financial markets and which allows them to identify the different effects that subjects’ risk attitudes and belief updating rules have on the information content of the order flow. They find that there are very few risk-neutral subjects and that subjects displaying risk aversion or risk-loving tend to ignore private information when their prior beliefs on the asset fundamentals are strong. Consequently, private information struggles penetrating trading prices. The authors find evidence of non-Bayesian belief updating (confirmation bias and under-confidence). This reduces (improves) market efficiency when subjects’ prior beliefs are weak (strong).

Keywords: risk attitude; financial market; information; belief; risk-neutral information

JEL-codes: F16; F17; F18

33 pages, May 19, 2009

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