Experimental Asset Market Research Articles

Macroprudential Policy in the Lab

We investigate the effect of leverage on bubbles in an asset market experiment. We expect higher leverage to produce larger bubbles because (i) it creates moral hazard in a setup with limited liability and (ii) it increases aggregate liquidity. Inconsistent with the moral hazard channel, which we test by holding aggregate liquidity constant, higher leverage does not produce larger bubbles. To understand this unexpected result, we run the same experiment with a different framing: instead of repaying debt, participants can earn a bonus. This bonus treatment produces larger bubbles, suggesting that more leveraged participants trade more cautiously to avoid default. Finally, bubbles are larger and increase over time when we keep leverage constant over time by injecting liquidity in the economy. Overall, these results suggest that higher leverage inflates bubbles not because of moral hazard but because of more abundant liquidity.

Designing Call Auction Institutions to Eliminate Price Bubbles: Is English Dutch the Best?

The bubble and burst pattern in asset market experiments is among the most replicable results in experimental economics. Numerous studies have searched for means to reduce this mispricing. Using controlled laboratory experiments, we compare mispricing in standard double auction markets to prices in two clock auctions. The double Dutch auction, shown to be more efficient than the double auction in commodity market experiments, does not eliminate bubbles. However, the English Dutch auction does yield prices reflective of underlying fundamentals and succeeds in taming bubbles even with inexperienced traders in the common declining fundamental value environment.

Bubbles, Crashes and Information Contagion in Large-Group Asset Market Experiments

We study the emergence of bubbles in a laboratory experiment with large groups of individuals. The realized price is the aggregation of the forecasts of a group of individuals, with positive expectations feedback through speculative demand. When prices deviate from fundamental value, a random selection of participants receives news about overvaluation. Our findings are: (i) large asset bubbles occur in large groups, (ii) information contagion through news affects behaviour and may break the coordination on a bubble, (iii) time varying heterogeneity provides an accurate explanation of bubble formation and crashes, and (iv) bubbles are strongly amplified by coordination on trend-extrapolation.

Heterogeneity of Beliefs and Trade in Experimental Asset Markets

We investigate the relationship between traders’ expectations and market outcomes with experimental asset market data. The data show that those who have high price expectations buy more frequently and submit higher bids, and those who hold low price expectations sell more frequently and submit lower bids. Traders who have more accurate expectations achieve greater earnings. Simulations using only belief data reproduce the pricing patterns observed in the market well, indicating that the heterogeneity of expectations is a key to explaining market activity.

Unleashing Animal Spirits: Self-Control and Overpricing in Experimental Asset Markets

One explanation for overpricing on asset markets is a lack of traders’ self-control. We implement the first experiment to address the causal relationship between self-control and systematic overpricing on financial markets. Our setup detects some of the channels through which low individual self-control could transmit into irrational exuberance in markets. Our data indicate a large direct effect of reduced self-control on market overpricing. Low self-control traders report stronger emotions after the market.

The 'Write' Size of Trading Behavior: Overconfidence, Prices, and Bubbles in Experimental Asset Markets

This study analyzes the role that overconfidence plays in investor trading behavior. Using a unique measure of confidence (signature size) with an experimental economics approach, we find that those who are more confident bid significantly higher for assets in simulated trading exercises. This is consistent with previous research that overconfident individuals put too much weight on private signals and/or valuations. We further find that markets with a higher percentage of overconfident individuals experience more mispricing and more overpricing.

Behavioral uncertainty and the dynamics of traders’ confidence in their price forecasts

By how much does the presence of behavioral uncertainty in an experimental asset market reduce subjects’ confidence in their price forecasts? An incentivized interval forecast elicitation method is employed to answer this question. Each market consists of six traders, and the value of dividends is known. Two treatments are considered: six human traders (6H), and one human interacting with five computer traders whose behavior is known (1H5C). We find that while the deviation of the initial price forecasts from fundamental value is smaller in the 1H5C treatment than in the 6H treatment, albeit not statistically significantly, the average confidence regarding the forecasts is not. We further analyze the relationships between subjects’ confidence in their forecasts and their trading behavior, as well as their trading performance, in the 6H treatment. While subjects’ high confidence in their short-term forecasts shows a negative correlation with their trading performance, high confidence in their long-term forecasts shows a positive correlation with trading performance.

Effects of different ways of incentivizing price forecasts on market dynamics and individual decisions in asset market experiments

In this study, we investigate (a) whether eliciting future price forecasts influences market outcomes and (b) whether differences in the way in which subjects are incentivized to submit “accurate” price forecasts influence market outcomes as well as the forecasts in an experimental asset market. We consider four treatments: one without forecast elicitation and three with forecast elicitation. In two of the treatments with forecast elicitation, subjects are paid based on their performance in both forecasting and trading, while in the other treatment with forecast elicitations, they are paid based on only one of those factors, which is chosen randomly at the end of the experiment. We found no significant effect of forecast elicitation on market outcomes in the latter case. Thus, to avoid influencing the behavior of subjects and market outcomes by eliciting price forecasts, paying subjects based on either forecasting or trading performance chosen randomly at the end of the experiment is better than paying them based on both. In addition, we consider forecast-only experiments: one in which subjects are rewarded based on the number of accurate forecasts and the other in which they are rewarded based on a quadratic scoring rule. We found no significant difference in terms of forecasting performance between the two.

Unleashing Animal Spirits - Self-Control and Overpricing in Experimental Asset Markets

One possible determinant of overpricing on asset markets is a lack of self-control abilities of traders. Self-control is the individual capacity to override or inhibit undesired behavioral tendencies such as impulses and to refrain from acting on them. We implement the first experiment that is able to address a potential causal relationship between self-control abilities and systematic overpricing on financial markets by introducing an exogenous variation of self-control abilities. Our experimental conditions seek to detect some of the channels through which individual self-control problems could transmit into irrational exuberance on the aggregate level. We observe a strong effect of inhibited self-control abilities on market overpricing. Our findings are furthermore robust to reducing self-control abilities only for a moderate share of traders in a market. Low self-control traders engage in more speculative behavior early on, but because others imitate their trading patterns, they do not end up earning less and are not driven out of the market.

Mind, Body, Bubble! Psychological and Biophysical Dimensions of Behavior in Experimental Asset Markets

Asset market bubbles and crashes are a major source of economic instability and inefficiency. Sometimes ascribed to animal spirits or irrational exuberance, their source remains imperfectly understood. Experimental methods can isolate systematic deviations from an asset's fundamental value in a manner not possible on the trading floor. In this chapter, we review evidence from dozens of laboratory experiments that investigate the measurement and manipulation of an array of psychological and biophysical attributes. Measures of emotion self‐regulation and interoceptive ability are informative, as is cognitive ability and the level and fluctuation of hormones.Rules that promote deliberative decision making can improve market efficiency, while incidental emotions can impair it. Signals in specific brain areas can be a trigger precipitating a bubble's collapse. We conclude that trading decisions are profoundly biophysical in a manner not captured by efficient markets models, and close with speculations on implications for algorithmic trading.

It is Not Just Confusion! Strategic Uncertainty in An Experimental Asset Market

To what extent is the observed mispricing in experimental asset markets caused by strategic uncertainty and by confusion? We address this question by comparing subjects' initial price forecasts in two market environments: one with six human traders, and the other with one human and five computer traders. We find that both strategic uncertainty and confusion contribute equally to the median initial forecast deviation from the fundamental value. The effect of strategic uncertainty is greater for subjects with a perfect score in the Cognitive Reflection Test, and it is not significant for those with low scores.

Accounting Standards and Financial Market Stability: An Experimental Examination

We examine the effects of three alternative accounting methods in an experimental asset market characterised by bubbles and crashes: fair value (M2M), historical cost (HC) and marked to fundamental value (M2F). Each treatment is replicated under both no‐leverage and leverage conditions. In the no‐leverage condition, we find that accounting methods do not have a significant effect on asset mispricing. In the leverage condition, both M2M and M2F accounting methods exacerbate asset mispricing. Yet, the two differ in leverage dynamics. M2F markets are completely immune to defaults, while M2M markets experience the most frequent and the most severe defaults.

Investors' Personality Influences Investment Decisions: Experimental Evidence on Extraversion and Neuroticism

ABSTRACTThe authors analyze the impact of individuals' degree of extraversion and neuroticism on their decision making in an experimental asset market. To establish this link between research on experimental asset markets and social psychology the authors use a unique approach that combines a questionnaire designed to assess individuals' degree of extraversion and neuroticism and an experimental asset market to assess individual financial decision making. The dataset combines 364 undergraduate business students' questionnaire responses and their trading behavior in the asset market. The authors find that extraversion and neuroticism significantly influence individuals' behavior in the experimental asset market. Specifically, more extraverted individuals pay higher prices for financial assets and they buy more financial assets when assets are overpriced than less extraverted individuals do. More neurotic individuals hold less risky assets in their financial portfolios than less neurotic individuals do. Although a large part of the explanatory power appears to be driven by gender differences, the authors still find significant impact of extraversion and neuroticism after controlling for gender effects. The study findings suggest that further research on financial markets could benefit from including personality of market participants as a crucial explanatory factor.

The Robustness of Mispricing Results in Experimental Asset Markets

Many experimental studies study market mispricing, however there is a distinct lack of guidance over how mispricing should be measured. This raises concerns about the sensitivity of mispricing results to variations in the measurement procedure. In this paper, we investigate the robustness of previous results with respect to four variations: 1) the choice of interval length, 2) the use of the bid-ask spread as a price proxy, 3) the choice of aggregation function, and 4) controlling for observable market characteristics. While a majority of previous results are unaffected, we still find that roughly 30% of previous hypothesis results change significance.

The Discovery of Bubbles and Crashes in Experimental Asset Markets and the Contribution of Vernon Smith to Experimental Finance

Southern Economic JournalVolume 83, Issue 3 p. 644-648 Symposium in Honor of Vernon Smith The Discovery of Bubbles and Crashes in Experimental Asset Markets and the Contribution of Vernon Smith to Experimental Finance Charles N. Noussair, Charles N. Noussair Economic Science Laboratory and Department of Economics, University of Arizona, Tucson, AZ 85724, USA; E-mail: cnoussair@email.arizona.edu.Search for more papers by this author Charles N. Noussair, Charles N. Noussair Economic Science Laboratory and Department of Economics, University of Arizona, Tucson, AZ 85724, USA; E-mail: cnoussair@email.arizona.edu.Search for more papers by this author First published: 29 January 2017 https://doi.org/10.1002/soej.12195Citations: 2 Read the full textAboutPDF ToolsRequest permissionExport citationAdd to favoritesTrack citation ShareShare Give accessShare full text accessShare full-text accessPlease review our Terms and Conditions of Use and check box below to share full-text version of article.I have read and accept the Wiley Online Library Terms and Conditions of UseShareable LinkUse the link below to share a full-text version of this article with your friends and colleagues. Learn more.Copy URL Share a linkShare onFacebookTwitterLinkedInRedditWechat Citing Literature Volume83, Issue3January 2017Pages 644-648 RelatedInformation

Trading While Sleepy? Circadian Mismatch and Excess Volatility in a Global Experimental Asset Market

Traders in global markets operate at different local times-of-day. Suboptimal times-of-day may produce sleepiness due to daily variations in sleep/wake patterns and possibly also increased accumulation of hours awake. Global asset markets imply significantly increased heterogeneity in circadian timing, and likely sleepiness, of trader decisions compared to localized markets. We examine these factors by administering single-location and global sessions of an online asset market experiment that regularly produces valuation bubble and crash events. Global sessions involved real time trades between subjects in two locations 16 time zones apart (i.e., “global” markets) and at varied local times of day across sessions. We find asset market bubbles occur in all sessions, but global markets had significantly more extreme and longer duration valuation bubbles. Additionally, subjects at the most suboptimal times-of-day held significantly more asset shares in their portfolios in late trading rounds compared to other subjects—a risky strategy with overvalued shares. Overall, our results highlight a unique but underappreciated factor present across traders in global market environments. They also point to the importance of a relatively common cognitive state (i.e., suboptimal time-of-day) in attempting to understand trader behavior and, ultimately, market outcomes. Key Words: Asset Markets, Experiments, Bubbles, Sleep, Circadian rhythm

Mental Capabilities, Trading Styles, and Asset Market Bubbles: Theory and Experiment

We propose that heterogeneous asset trading behavior is the result of two distinct, non-convertible mental dimensions: analytical (“quantitative”) capability and mentalizing (“perspective-taking”) capability. We develop a framework of mental capabilities that yields testable predictions about individual trading behavior, revenue distribution and aggregate outcomes. The two-dimensional structure of mental capabilities predicts the existence of four mental types with distinguishable trading patterns and revenues. Individuals will trade most successfully if and only if they have both capabilities. On the other hand, subjects who can mentalize well but have poor analytical capability will suffer the largest losses. As a consequence, being able in just one dimension does not assure trading success. We test these implications in a laboratory environment, where we first independently elicit subjects’ capabilities in both dimensions and then conduct a standard asset market experiment. We find that individual trading gains and patterns are consistent with our theoretical predictions. Our results suggest that two mental dimensions are necessary to encompass the complex heterogeneous behaviors in asset markets; a one-dimensional measure of mental capability will lead to biased conclusions. The findings have potential implications for financial institutions, which can use the measures to select successful traders, or for policy-makers, helping them to prevent the formation of asset bubbles. Finally, our conceptual framework and the empirical screening method could be applied to explain heterogeneous behavior in other games.

Overconfidence and Bubbles in Experimental Asset Markets

ABSTRACTThis paper investigates the relationship between market overconfidence and occurrence of stock-price bubbles. Sixty participants traded stocks in 10 experimental asset markets. Markets were constructed on the basis of subjects' overconfidence: The most overconfident subjects form high overconfidence markets and the least overconfident subjects low overconfidence markets. Prices in low overconfidence markets tend to track the fundamental asset value more accurately than prices in high overconfidence markets and are significantly lower and less volatile. Additionally, we observe significantly higher bubble measures and trading volume in high overconfidence markets. Two possible explanations for these differences are analyzed: While price expectations are significantly higher in high overconfidence markets, no differences in the average degree of risk aversion were detected.

Fundamentals, momentum, and bubbles in experimental asset markets

Purpose – The purpose of this paper is to report the results of a study concerning how fundamental-motivated investors, and their subsequent impact on the path of prices, affect the severity of price bubbles in an experimental laboratory asset market. Design/methodology/approach – In a laboratory experiment, asset markets are manipulated by systematically replacing inexperienced human traders with automated traders programmed to submit bids and asks at fundamental value. Findings – When traders in a market are automated to invest on fundamentals, deviations from fundamental value are initially suppressed, but reappear when automated traders cease to influence prices. A significant reduction in the severity of the resulting bubble may be attributed to the interaction of automated traders and humans through the initial path of prices when controlling for changes in liquidity. This reduction corresponds to reduced autocorrelation in the time series of returns. Originality/value – This paper represents the first attempt (to the authors’ knowledge) to extend the intervention approach of the seminal paper by Smith et al. (1988) to systematically study the extent to which manipulation of initial path of prices impacts the formation and magnitude of bubbles in the laboratory.

Price Dynamics and Consumption Smoothing in Experimental Asset Markets

We report the results of an experiment designed to study the determinants of asset price movement and consumption smoothing behavior across asset markets populated with varying proportion of traders with and without having induced motive to smooth consumption. Although the asset is over-priced compared to the risk-neutral fundamental value in all sessions, the extent of over-pricing and magnitude of price movement is significantly higher when traders with no induced motive to trade are present. We also find that the price of the asset co-moves with the dividend state, with price predictability being higher in the presence of traders with induced motive to smooth consumption. Participants motivated to minimize consumption fluctuations are able to do so with the inclination being more for those having lower initial endowment. With fixed prices, traders are able to smooth consumption not only over periods but also over the dividend states.