Reading the Market? Expectation Coordination and Theory of Mind

Abstract

Suppose that all asset market traders are proficient at reading the market. Would markets become more stable, resulting in lower volatility and fewer price bubbles? To answer this question, we test whether Theory of Mind (ToM) capabilities enhance expectation coordination and reduce expectation heterogeneity and price bubbles in learning-to-forecast experiments. We compare the price and expectation dynamics between markets composed of participants with either high or low ToM capabilities as measured by the eye gaze test. Despite an economically substantial difference between the two groups, we find no statistically significant differences in the measures of expectation coordination, price bubbles, market stability, and expectation heterogeneity.