Insider trading, imitative behaviour and price formulation in a stimulated double-auction stock market

This paper presents the results of a series of experiments in a simulated double-auction stock market. Price formation was observed under various manipulations of asymmetric information and communication, including conditions intended to promote imitative behaviour and rumour. Inefficient prices were observed when the presence of insiders was completely disguised – that is, prices reflected the expectations of non-insiders. When the presence (but not the identity) of insiders was revealed there was a sharp increase in imitative behaviour that appeared to be one-sided – observed prices became efficient with respect to bad news but not with respect to good news. When subjects were allowed to communicate uncertain information to create a climate of rumour (they could lie, tell the truth and/or spread rumours but were forbidden to prove the veracity of any communication) there was a decrease in both efficiency and price volatility – that is, informational noise appeared to mask the signals of insiders. Price formation under these conditions was similar to the homogeneous expectations baseline, but there was also some evidence of speculative pricing