Herding and Contrarian Behavior in Financial Markets: An Internet Experiment

We report results of an internet experiment designed to test the theory of informational cascades in financial markets (Avery and Zemsky, AER, 1998). More than 6000 subjects, including a subsample of 267 consultants from an international consulting firm, participated in the experiment. As predicted by theory, we find that the presence of a flexible market price prevents herding. However, the presence of contrarian behavior, which can (partly) be rationalized via error models, distorts prices, and even after 20 decisions convergence to the fundamental value is rare. We also study the effects of transaction costs and the expectations of subjects with respect to future prices. Finally, we report some interesting differences with respect to subjects' fields of study.