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Efficient markets in the presence of an "irrational" investor: the case of the Insead ball ticket market

Author: Rau, P. Raghavendra INSEAD Area: Economics and Political Science Series: Working Paper ; 95/66/FIN/EPS Publisher: Fontainebleau : INSEAD, 1995.Language: EnglishDescription: 18 p.Type of document: INSEAD Working Paper Online Access: Click here Abstract: An efficient market is supposed to aggregate all avaible and relevant information into prices. Consequently, prices change only because of the unexpected arrival of new information. This information is usually related to factors governing the supply and demand of goods in the market. We examine a case at a business school in Europe where one trader in a sophisticated e-mail market announced that he was trading on ethical considerations rather than on profit maximization considerations as the others were. This announcement caused the entire market to collapse. We hypothesize that this is because the announcement made it no longer common knowledge that all market participants were rational, which caused a consequent breakdown in the market. The phenomenon emphasizes how critical is the usually unstated assumption of the common knowledge of rationality of the participants and suggests that the traditional analyses of "irrational" "noise" trader risk may not capture all the effects of irrationality
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An efficient market is supposed to aggregate all avaible and relevant information into prices. Consequently, prices change only because of the unexpected arrival of new information. This information is usually related to factors governing the supply and demand of goods in the market. We examine a case at a business school in Europe where one trader in a sophisticated e-mail market announced that he was trading on ethical considerations rather than on profit maximization considerations as the others were. This announcement caused the entire market to collapse. We hypothesize that this is because the announcement made it no longer common knowledge that all market participants were rational, which caused a consequent breakdown in the market. The phenomenon emphasizes how critical is the usually unstated assumption of the common knowledge of rationality of the participants and suggests that the traditional analyses of "irrational" "noise" trader risk may not capture all the effects of irrationality

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