Price-conveyed Information versus Observed Insider Behavior: A Note on Rational Expectations Convergence

Abstract

In a recent paper on behavior in experimental securities markets, Plott and Sunder ( 1982) concluded that the rational expectations (RE) model was superior to the traditional prior information (Pl) model in predicting equilibrium prices and holdings. In particular, given a market with one commodity, three possible states of the world, and three groups of trader types, each with differing valuations on the commodity per state, initially uninformed traders were able to infer the underlying state from the current market price and act accordingly. In a related paper, Friedman, Harrison, and Salmon (1984) observed that, given the existence of a futures market, the RE model outperformed the PI model in multiperiod, single-commodity markets as well. One source of potential misinterpretation, however, comes from the fact that, although one-half of the traders of each type were informed of the true state at the beginning of each period in Plott and Sunder (1982) and one-third of the traders of each type in Friedman, Harrison, and Salmon (1984), the same traders were informed in almost every period. In a more recent paper, Plott and Sunder (1983) constructed markets where all traders received partial information (i.e., given possible states X, Y, and Z, a trader's private information would be either not X or not Y if the state were Z), yet the combinations of traders receiving a certain message in any period were determined randomly.