The effect of ambiguity on price formation and trading behavior in financial markets

  • This paper sets up an experimental asset market in the laboratory to investigate the effects of ambiguity on price formation and trading behavior in financial markets. The obtained trading data is used to analyze the effect of ambiguity on various market outcomes (the price level, volatility, trading activity, market liquidity, and the degree of speculative trading) and to test the quality of popular empirical market-based measures for the degree of ambiguity. We find that ambiguity decreases market prices and trading activity; ambiguity leads to lower market liquidity through wider bid-ask spreads; and ambiguity leads to less speculative trading. We also find that popular market-based measures of ambiguity used in the empirical literature do not seem to correctly capture the true degree of ambiguity.

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Author:Wenhui Li, Peter Ockenfels, Christian Wilde
Parent Title (English):SAFE working paper ; No. 326
Series (Serial Number):SAFE working paper series (326)
Place of publication:Frankfurt am Main
Document Type:Working Paper
Year of Completion:2021
Year of first Publication:2021
Publishing Institution:Universit├Ątsbibliothek Johann Christian Senckenberg
Release Date:2021/11/22
Tag:ambiguity; bid-ask spread; financial market; laboratory experiment; market price; market-based; measure of ambiguity; trading activity; volatility
Issue:November 2, 2021
Page Number:41
Institutes:Wirtschaftswissenschaften / Wirtschaftswissenschaften
Wissenschaftliche Zentren und koordinierte Programme / House of Finance (HoF)
Wissenschaftliche Zentren und koordinierte Programme / Center for Financial Studies (CFS)
Wissenschaftliche Zentren und koordinierte Programme / Sustainable Architecture for Finance in Europe (SAFE)
Dewey Decimal Classification:3 Sozialwissenschaften / 33 Wirtschaft / 330 Wirtschaft
Licence (German):License LogoDeutsches Urheberrecht