A test of the Modigliani-Miller theorem, dividend policy and algorithmic arbitrage in experimental asset markets

Abstract

Modigliani and Miller showed that the market value of the company is in- dependent of its capital structure, and suggested that dividend policy makes no dierence to this law of one price. We experimentally test the MM theorem in a complete market with two simultaneously traded assets, employing two experimental treatment variations. The first variation involves the dividend stream. According to this variation the dividend payout order is either identi- cal or independent. The second variation involves the market participation, or not, of an algorithmic arbitrageur. We find that Modigliani-Miller's law of one price can be supported on average with or without arbitrageur when dividends are identical. The law of one price breaks down when dividend payout order is independent unless the arbitrageur keeps the asset prices in balance.