Markets, Information, and Feedback

Abstract

The efficient market hypothesis states that security prices fully reflect all the information in the market and should therefore match the true value of the security. However, the price of a security may affect decisions that then in turn affect prices. For instance, the price of a stock in a firm may affect CEO ownership. The ownership may affect incentives. This may explain why firms with high CEO ownership are consistently traded below value and yield excess returns to stockholders. We test this proposed mechanism in a controlled experiment. We find that introducing moral hazard indeed leads to excess returns as predicted by theory. Mandatory disclosure policies have two effects. On the one hand, they facilitate price convergence and increase efficiency. On the other hand, they allow the managers to extract funds from shareholders due to myopic trading.

Another area where market feedback may occur is with prediction markets. We plan to use expert prediction markets to elicit, aggregate, and summarise knowledge on future climate risks, drawing on expertise from diverse areas of physical, social, and policy science. However, results from the market may affect policy decisions. Can relevant information still be extracted from these markets?