On the Information Content of the Order Flow: An Experiment

We report results of a series of experiments 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 attitudes and belief updating rules have on market informational efficiency. On the one hand, we show that many of the so called "irrational" behaviors are not so if one takes into account subjects' risk attitude. On the other hand we find evidence of non-Bayesian updating of beliefs. 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 implies that when the market has a sharp opinion on an asset fundamental value, the private information dispersed in the economy struggles to enter trading prices. Non-Bayesian belief updating has an ambiguous effect on market efficiency as it reduces (improves) the information flow when subject prior belief is weak (strong).