From Columbia Law School's CLS Blue Sky blog:
What are the consequences of increasing public information in a market of risk-seeking participants? Academics and policy makers alike are grappling with this question following the influx of speculative capital flows from individual investors in financial markets. As platforms such as Robinhood take root, the influence of gambling behavior is likely to increase and further affect the functioning of markets. The topic is also a key policy issue in light of the Securities and Exchange Commission (SEC) plan to review new policies aimed at increasing transparency to address market developments such as the frenzy of trading in “meme” stocks like GameStop and AMC.
In a new study, we examine the effect of increasing information on capital flows and market efficiency in a setting with market participants who have revealed gambling preferences. Theory highlights at least a few possibilities.
- One class of theoretical models posits that risk-averse individuals demand a risk premium to hold assets that are not transparent. Of course, this argument flips for risk-seeking participants. So, this line of reasoning suggests that an increase in information will lead to an exodus of capital from the markets.
- A second argument is that an increase in public information can lead to better allocation of resources, even for gamblers. More information can help participants pick risky investments with the level of speculation that is of interest to gamblers. Thus, asset classes with more information could receive more speculative capital flows.
- The third alternative arises from behavioral economics. Individuals deviate from standard utility theory when making choices in the face of uncertainty due to cognitive errors and misperceptions of probabilities. In this context, they may exhibit an illusion of control. Even in chance situations, agents often wrongly believe they can exercise control over the outcome – a canonical example is craps players “setting” the dice. The fundamental issue relevant to debates about transparency is that information itself can exacerbate this false sense of control. For instance, public information and related tools that supposedly aid the decision process can magnify bettors’ perceived control, persuading them to bet even more (and more recklessly).
For our empirical approach, we turn to the thoroughbred horserace betting market and exploit a near-laboratory setting. We focus on how race betting changed around April 1992, when Beyer speed figure (“Beyer”) information was made available for races at North American tracks as part of the Daily Racing Form (DRF), the dominant provider of handicapping information for bettors at the time. The Beyer is a popular numerical measure of a racehorse’s speed based on past performance in races, designed to facilitate comparisons of horses’ abilities. In this way, the Beyer is representative of much information in financial markets – it is a summary measure of performance that enhances comparability, akin to similar measures imposed via financial disclosure regulations, such as prior period earnings, credit ratings, etc.
As a textbook model of contingent markets, horserace betting has been used as a way to test theories of information aggregation, market efficiency, and other topics in economics and finance. Both securities markets and horserace betting represent decision-making under conditions of risk or uncertainty and share characteristics such as extensive market knowledge....
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Also at CLS Blue Sky, Big Law sees broad sunlit uplands:Debevoise & Plimpton Discusses Expanded Horizons for Class Action Litigation in the UK
