Reaction to information in financial markets and its effect

Abstract

This study examines the reaction to information and its effects, encompassing three key aspects. First, it investigates the integration of diverse information by information receivers. Examining this area helps establish information transmission models and understand investors' information risk awareness. Second, the research explores how information disclosure requirements influence the reactions of participants. The findings from this investigation can provide guidance for suitable information disclosure requirements applied by different platforms. Third, the study delves into the reactions of participants when facing a shock and its relationship with flash crashes. This component enables the observation of interactions among different participants and how their reaction character influences market stability.

In peer-to-peer (P2P) markets, such as P2P lending and crowdfunding, applicants seek funding by disclosing unverifiable information (soft information) and verifiable information (hard information) on the platform. Chapter 3 investigates the integration of hard and soft information by funders in peer-to-peer markets through a controlled experiment. Specifically, it simulates the information integration process. A total of 245 participants, acting as funders, provided their ratings for 199 stylized peer-to-peer funding requests. Each funding request was presented with a narrative (soft information) and a score (hard information). Findings indicate that participants assign greater weight to soft information compared to hard information. However, the role of soft information is weakened by the discrepancy between hard and soft information, as well as the ambiguity inherent in soft information. Interestingly, the inclusion of hard information that captures others' assessments of the funding requests amplifies the impact of soft information due to confirmation bias.

Chapter 4 focuses on information disclosure requirements, which determine whether applicants must disclose soft information, hard information, or both. A signaling game model is created to analyze the interaction between applicants and the market and to study the impact of disclosure requirements imposed by P2P platform operators. The findings indicate that requirements allowing only soft information to be sent are beneficial to applicants but pose more risk to the market. In contrast, requirements allowing only hard information have the opposite effect. Importantly, the results suggest that allowing both types of information, soft and hard, helps to balance information asymmetry and the difficulty of obtaining financing in the P2P market.

Chapter 5 differentiates traders in the stock market based on their reaction speed to information into fast and slow traders and examines the dynamics between fast and slow traders under a market shock, which can potentially trigger a flash crash. Shock size, liquidity, the fraction of fast traders, and trend trading indirectly affect trader behavior. Findings indicate that the size of the shock positively relates to the probability of a flash crash, while liquidity mitigates this effect. Furthermore, the behavior of high-frequency traders withdrawing orders increases the probability of a flash crash in undervalued markets. Trend trading exhibits a dual role: it mitigates the probability of a flash crash during small shocks but exacerbates it during larger shocks.