Essays on rational behavior in incomplete information
Abstract
This thesis examines the behavior of rational agents in market settings
of incomplete information using tools of signal-jamming and signaling. I
study the decision-making processes of agents who aggregate information by
updating noisy information, knowing that their own actions may reveal private
information to others, and knowing that others face the same problems.
The first essay analyzes how the existence of noise traders causes a reporting
and pricing bias in a “rational” financial market when managers may
be signal-jamming by over-reporting earnings. I assume that traders differ in
their available information on the possible reporting bias of a manager, and
that the manager has private interests in manipulating the stock price. I conclude
that the existence of noise traders causes systematic pricing bias and
leads to an “inefficient” financial market. I also analyze the effects financial
market structure and accounting systems regulation have on pricing bias and
reporting bias. For example, I show that market pricing bias is lower if there
are more people who are better informed about the manager’s private interest
in manipulating the stock price, even though it leads directly to a higher reporting
bias.
The second essay theoretically investigates the factors influencing an
established firm’s decision whether or not to introduce a new product under
the same brand name, that is, to stretch the brand. I assume that a firm
has better knowledge of the product’s quality than consumers do; that the
characteristics of the established and the new products are related; and that
consumers infer as much as possible from prices and brand name. The size of
the original market relative to the new market and consumers’ ability to judge
quality in both markets combine to determine the magnitude of backward or
forward effects. I confirm Cabral’s (2000) conjecture that the greater the similarity
of products (i.e., higher correlation of qualities), the less frequent brand
stretching occurs when the original good is perceived as being high quality.
However, in contrast to Cabral, as consumers gain higher accuracy in perceiving
the quality of the goods, if the original good is perceived as being of low
quality, then higher correlation between the products leads to more frequent
brand stretching. The present analysis also sheds light on the importance of
consumers’ ability to accurately detect quality—the more accurate consumers
are, the less important is any strategic signaling by the firm.
The last essay examines a combined idea of previous two essays in different
context, which is whether or not a fund manager in the established market
can signal his superior ability in a new financial market. The better informed
traders in a stock market may have a chance to trade in other financial sectors,
e.g. the bond market. His ability in the new market may be different from the
previous ability and is a private information. Now the decision of the manager
is whether or not to introduce an additional performance fee considering both
backward and forward effects. As in the second essay, the manger with the
ability of high performance in the new market declares his type by charging
the additional fee.
Department
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