| In this thesis, I study how traders in financial markets learn by observing the actions of one another. In the first part of the dissertation, I analyze this issue theoretically. In the second part, I study the problem through an experimental study.; A well-documented regularity of financial markets is that there are periods in which traders neglect their own information and imitate the decisions of previous agents. I study whether this can occur in a two-asset economy where rational agents trade sequentially. First, with gains from trade or uncertainty on the proportion of traders with private information, informational cascades (i.e., situations in which agents do not use their own information) arise and prices fail to aggregate information dispersed among traders. During a cascade all informed traders with the same preferences choose the same action, i.e., they herd. Second, sequential trading helps to explain contagion, since the correlation between prices can be higher than between fundamentals. Informational cascades and herds can spill over from one asset to the other, pushing the prices far from the fundamentals.; In the second part, I test through an experimental study the results on herd behavior and informational cascades obtained in the first part. Agents in the laboratory trade an asset whose value is unknown and whose price is efficiently set by a market maker. I show that when agents trade only for informational reasons and there are no frictions in the market, the presence of a price mechanism destroys the possibility of herding. Most agents follow their private information and prices converge to the fundamental value. These results contrast with the previous experimental literature, where the price was kept constant and herding and cascades arose. When the price moves, however, agents may behave as contrarian, i.e., they may trade against the market, something not accounted for by the theory. When there is a wedge between the traders' and the market maker's valuations, however, informational cascades and herding arise—as predicted by the theoretical analysis. In this case, the price may be unable to aggregate private information and converge to the fundamental value of the asset. |
