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Rational Price Discovery In Experimental And Field Data

Bossaerts, Peter (1995) Rational Price Discovery In Experimental And Field Data. Social Science Working Paper, 952. California Institute of Technology , Pasadena, CA. (Unpublished)

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The methodology of tests for martingale properties in return series is analyzed. Martingale results obtain frequently in finance. One case is focused on here, namely, rational price discovery. Price discovery is the process by which a market moves towards a new equilibrium after a major event. It is rational if price changes cannot be predicted from commonly available information. The price discovery process, however, cannot be assumed stationary. Hence, to avoid false inference in the presence of nonstationarities, event studies of field data have been advocating the use of cross-sectional information in the computation of test statistics. Under the martingale hypothesis, however, this inference strategy is shown to add little except if higher moments of the return series do not exist. On the contrary, the cross-sectional approach may even be invalid if there is cross-sectional heterogeneity in the price discovery process. The time series statistic of Patell (1976], originally suggested in the context of i.i.d. time series but cross-sectional heterosceclasticity, may be preferable. It will not provide valid inference either, if higher serial correlation coincides with higher volatility. Unfortunately, this appears to be the case in the dataset which is used in the paper to illustrate the methodological issues, namely, transaction price changes from experiments on continuous double auctions with stochastic private valuations.

Item Type:Report or Paper (Working Paper)
Bossaerts, Peter0000-0003-2308-2603
Additional Information:The content of this paper was the basis of an invited talk at the 1994 European Summer meetings of the Econometric Society. Charles Plott and David Porter generously provided the author with their experimental data. They and Tom Palfrey commented on an earlier draft. The research was partly supported through a grant from First Quadrant to the California Institute of Technology.
Group:Social Science Working Papers
Funding AgencyGrant Number
Subject Keywords:Price Discovery, Rational Expectations, Martingales, Nonstationarity, Nonergodic Central Limit Theorems, Event Studies, Experimental Economics.
Series Name:Social Science Working Paper
Issue or Number:952
Record Number:CaltechAUTHORS:20170817-134647024
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Usage Policy:No commercial reproduction, distribution, display or performance rights in this work are provided.
ID Code:80567
Deposited By: Jacquelyn Bussone
Deposited On:21 Aug 2017 17:20
Last Modified:03 Oct 2019 18:32

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