Get access

How Do Market Prices and Cheap Talk Affect Coordination?

Authors


  • Accepted by Christian Leuz. This study is based on my dissertation completed at Carnegie Mellon University. I am indebted to my committee for their valuable guidance and suggestions: John O'Brien (Chair), Jonathan Glover, Jack Stecher, Don Moser, and John Duffy. I thank two anonymous referees, Stanley Baiman, Orie Barron, Jeremy Bertomeu, Paul Fischer, Pingyang Gao, Frank Heinemann, Burton Hollifield, Steve Huddart, Karim Jamal, Tony Kwasnica, Carolyn Levine, Richard Lowery, and Roberto Weber for helpful comments. I would also like to thank participants’ for comments at the 2009 International Experimental Economics Conference, Center of Organizational Learning and Innovation conference in 2010, Carnegie Mellon University, Penn State University, University of Alberta, University of Chicago, University of Pennsylvania, and Yale University. I thank Financial Trading System (FTS) for allowing me to use the FTS trading software. Funding from the Center of Organizational Learning and Innovation at Carnegie Mellon University is gratefully acknowledged.

ABSTRACT

In many scenarios such as banking and liquidity crises, inefficiencies often arise because investors face uncertainties about economic fundamentals and the strategies of other investors. How information affects fundamental uncertainty is well studied, but how information affects strategic uncertainty is underexplored. This paper examines how two communication mechanisms, market and cheap talk, affect investment decisions and efficiency in an experimental investment game with both fundamental and strategic uncertainty. I find that the market does not improve coordination because the expectation that coordination failures will occur is self-fulfilling, while cheap talk improves coordination because the signals of willingness to invest alleviate strategic uncertainty.

Ancillary