Marco Cipriani

Herd Behavior and Contagion in Financial Markets

We study a sequential trading financial market where there are gains from trade, that is, where informed traders have heterogeneous private values. We show that an informational cascade (i.e., a complete blockage of information) arises and prices fail to aggregate information dispersed among traders. During an informational cascade, all traders with the same preferences choose the same action, following the market (herding) or going against it (contrarianism). We also study financial contagion by extending our model to a two-asset economy. We show that informational cascades in one market can be generated by informational spillovers from the other. Such spillovers have pathological consequences, generating long-lasting misalignments between prices and fundamentals.

Transaction Costs and Informational Cascades in Financial Markets: Theory and Experimental Evidence

We study the effect of transaction costs (e.g., a trading fee or a transaction tax, like the Tobin tax) on the aggregation of private information in financial markets. We analyze a financial market a la Glosten and Milgrom, in which informed and uninformed traders trade in sequence with a market maker. Traders have to pay a cost in order to trade. We show that, eventually, all informed traders decide not to trade, independently of their private information, i.e., an informational cascade occurs. We replicated our financial market in the laboratory. We found that, in the experiment, informational cascades occur when the theory suggests they should. Nevertheless, the ability of the price to aggregate private information is not significantly affected.

Leverage and Asset Prices: An Experiment

This is the first paper to test the asset pricing implication of leverage in a laboratory. We show that as theory predicts, leverage increases asset prices: when an asset can be used as collateral (i.e., when the asset can be bought on margin), its price goes up. This increase is significant, and quantitatively close to what theory predicts. However, important deviations from the theory arise in the laboratory. First, the demand for the asset shifts when it can be used as a collateral, even though agents do not exhaust their purchasing power when collateralized borrowing is not allowed. Second, the spread between collateralizable and non-collateralizable assets does not increase during crises in contrast to what theory predicts.

Informational Contagion in the Laboratory

We study the informational channel of financial contagion under laboratory conditions. In our experiment, two markets with correlated fundamentals open sequentially and in both of them subjects receive private information. Subjects in the market opening second also observe the history of trades and prices in the first market. We find that although in both markets private information is only imperfectly aggregated, subjects are able to make correct inferences based on the public information coming from the market that opens first. We thus observe financial contagion under laboratory conditions: the correlation between asset prices is very close to that predicted by the theory. Moreover, as the theory predicts, there is no contagion when asset fundamentals are independent: in other words, subjects only react to the history of prices and trades in the first market when it is rational to do so because they convey information.

Money Market Funds Intermediation, Bank Instability, and Contagion

In recent years, U.S. banks have increasingly relied on deposits from financial intermediaries, especially money market funds (MMFs), which collect funds from large institutional investors and lend them to banks. In this paper, we show that intermediation through MMFs allows investors to limit their exposure to a given bank (i.e., reap gains from diversification). However, since MMFs are themselves subject to runs from their own investors, a banking system intermediated through MMFs is more unstable than one in which investors interact directly with banks. A mechanism through which instability can arise in an MMF-intermediated financial system is the release of private information on bank assets, which is aggregated by MMFs and could lead them to withdraw en masse from a bank. In addition, we show that MMF intermediation can also be a channel of contagion among banking institutions.

Investorss Appetite for Money-Like Assets: The Money Market Fund Industry after the 2014 Regulatory Reform

This paper uses a quasi-natural experiment to estimate the premium investors are willing to pay to hold money-like assets. The 2014 SEC reform of the money market fund (MMF) industry reduced the money-likeness only of prime MMFs, by increasing the information sensitivity of their shares, and left government MMFs unaffected. As a result, investors fled from prime to government MMFs, with total outflows exceeding

Herd Behavior in Financial Markets

1 trillion. By comparing investors? response to the regulatory change with past episodes of industry dislocation (for example, the 2008 MMF run), we highlight the difference between a desire to preserve money-likeness and a simple flight to safety. Using a difference-in-differences design that exploits the differential treatment of prime and government MMFs, as well as institutional and retail share classes, we estimate the premium for money-likeness to be 20 basis points for retail investors and 28 basis points for institutional ones (who have been more affected by the regulation). Using family specialization as an instrument for fund yields, we are able to identify the elasticity of substitution between prime and government institutional MMF shares: the regulation caused the elasticity to decrease from 0.50 to 0.11.

Like Mother Like Son? Experimental Evidence on the Transmission of Values from Parents to Children

Over the last twenty-five years, there has been a lot of interest in herd behavior in financial markets?that is, a trader?s decision to disregard her private information to follow the behavior of the crowd. A large theoretical literature has identified abstract mechanisms through which herding can arise, even in a world where people are fully rational. Until now, however, the empirical work on herding has been completely disconnected from this theoretical analysis; it simply looked for statistical evidence of trade clustering and, when that evidence was present, interpreted the clustering as herd behavior. However, since decision clustering may be the result of something other than herding?such as the common reaction to public announcements?the existing empirical literature cannot distinguish ?spurious? herding from ?true? herd behavior.