Trading Case RE2

 

 

Case Objective

To understand market efficiency information revelation through prices when asset payoffs are correlated.

 

Key Concepts

Market efficiency; rational expectations.

 

Case description

There are three stocks, traded over two periods.  The values of the stocks at the end of the second period depend on whether the firms win some lucrative contracts.   The interest rate each period is set at 0%, so the time value of money plays no role in this case.  You can borrow at this rate and also short sell the stocks. 

 

In each period, a firm can win or not win contracts.  Winning all the contracts is the best event, while not winning anything is the worst event.  Firms 2 and 3 compete for the same contract, so a good event for one is bad for the other.  Firm 1 competes in a separate market.  The events determine the dividends paid by the firms at the end of period 1 and also the value of the firm at the end of period 2. You may receive information about these events.  Prices in this case are determined by the traders.

 

Case Data

The next table describes the events and shows the dividends paid by each firm at the end of period 1 depending on the period 1 event.

 


 

 

Firm 1

Firm 2

Firm 3

Event x

Failure to win any contract

0

0

30

Event y

Wins some contracts

12

15

15

Event z

Wins all the contracts

24

30

0


For firm 3, event x is the best event and z is the worst event.  The values of the firms at the end of the second period depend on bidding success in each period:

 

Period 1 event

Period 2 events

 

Firm 1

Firm 2

Firm 3

 

x

y

z

x

y

z

x

y

z

x

50

50

100

0

50

100

150

100

50

y

50

100

150

0

75

150

150

75

0

z

50

150

150

50

100

150

100

50

0

 

Grade Cash

Your aim is to make as much money as you can.  At the end of each trial you earn grade cash as 0.0001 x market cash.  That is, if you end up with negative wealth then you lose grade cash and if you make money then you gain grade cash.  Trading is conducted over a number of independent trials and a record of your cumulative grade cash is maintained.

 

Generic Trading Screen

 

Move the mouse to different parts of the screen online for "mouse-over" help.

 

 

 

OS Financial Trading System 2001