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Learning from others, reacting, and market quality

Chakrabarti, Rajesh and Roll, Richard (1999) Learning from others, reacting, and market quality. Journal of Financial Markets, 2 (2). pp. 153-178. ISSN 1386-4181. doi:10.1016/s1386-4181(98)00011-1.

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Traders pay attention to one another but are unable to perfectly deduce each others’ beliefs from transactions alone. This explains why markets are hard to beat and also why trading occurs at all. Even when traders react rationally to the actions of others, they cannot arrive easily at a common posterior assessment of value. We model a realistic market composed of traders who combine their own private information with rational learning about the information possessed by others. We compare phenomena in this market with an otherwise identical market populated by traders who receive the same private information but ignore other traders. Using simulation to engender greater realism, we find that learning usually reduces volatility, increases the accuracy of the market price as a forecast of value, reduces trading volume, and decreases the prevalence of bubbles. However, for some combinations of market conditions, learning can have the opposite effect. The marginal influences of eight different market conditions, ranging from information heterogeneity through resource diversity, are estimated. Prices, volatility, volume, and bubbles exhibit subtle and complex responses to market conditions.

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Additional Information:© 1999 Published by Elsevier. Available online 21 June 1999. Without blame, many thanks for comments and suggestions received on an earlier version of the paper from Antonio Bernardo, Blake LeBaron, Olivier Ledoit, Bruce Lehmann, Tai Ma, David Mayers, Mark Stohs, an anonymous referee and participants in seminars at the Asia/Pacific Finance Conference, California State University Fullerton, the National Bureau of Economic Research, the University of California-Riverside, and National Sun-Yat Sen University.
Subject Keywords:Learning; Incomplete information; Volatility; Market Quality
Issue or Number:2
Classification Code:JEL classification G10; D83
Record Number:CaltechAUTHORS:20190426-145911277
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Official Citation:Rajesh Chakrabarti, Richard Roll, Learning from others, reacting, and market quality. Journal of Financial Markets, Volume 2, Issue 2, 1999, Pages 153-178, ISSN 1386-4181, (
Usage Policy:No commercial reproduction, distribution, display or performance rights in this work are provided.
ID Code:95049
Deposited By: George Porter
Deposited On:29 Apr 2019 20:33
Last Modified:16 Nov 2021 17:09

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