Naave News Trading: Experimental Evidence

Abstract

This study documents experimental evidence that naive beliefs about the behavior of others contribute to excessive trading. The mechanism is based on the idea that when people process new information they naively neglect other market participants’ reaction to the information and consequently trade too much. In a series of laboratory experiments, I find that people actively trade on information that they should expect to be already incorporated into the price by other players. In line with naive news trading, people underestimate the response of others to new information and consequently trade too much compared to the rational benchmark. A simple model with naive investors who partially neglect that other investors respond to new information provides a good fit of the observed trading behavior.