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Information Asymetry and Price Formation When Cognitive Biases Affect Traders' Strategies

Behavioral Finance aims to propose a theoretical alternative to EMH (Efficient Market Hypothesis), allowing for not fully rational behavior. Understanding price formation when some agents are victim of cognitive biases is one of the most important research fields. We propose an extension of Grossman et Stiglitz (1980)'s framework by integrating investors, who do not update their beliefs fully rationaly, using (1)incorrect priors and/or failing to assess correctly the quality of their private signal. We evaluate the impact of the considered bias on the efficiency of the price system and show that individual biases are partially transmitted to uninformed agents, who try to infer the private signal.