On the Information Content of the Order Flow: an Experiment

Abstract

We report results of an experiment that simulates trading in financial market. The specific format of our experiment allows to unambiguously measure the information content of the order flow and to disentangle the impact that risk attitude and non-Bayesian updating have on market informational efficiency. We show that many of the so called "irrational" behavior are not so if one takes into account subjects' risk attitude. Risk neutral subjects are rare and subjects displaying risk aversion or risk loving tend to ignore private information when their prior beliefs on the asset fundamentals are strong. This behavior possibly generates informational cascade. We find clear evidence of non-Bayesian updating. Its effect on market efficiency is ambiguous. Non-Bayesian updating reduces (improves) the information flow when subject prior belief is weak (strong).