Experimental Asset Market Research Articles

The determinants of predatory trading: experimental evidence

We investigate the level and determinants of front-running in an experimental asset market game. Participants receive perfect signals about future order-flow that can be exploited to manipulate prices and generate profits. We quantify the changes in front-running activity as we vary the direction, concentration, and noise level of the scheduled order flow. Front-running activity increases with larger, more concentrated, or buy-side anticipated future orders and decreases with noise. Our findings suggest that the inclusion of a large stock in an index should be done in multiple stages to reduce the trading cost of passive investors tracking the index.

The role of the end time in experimental asset markets

There are hundreds of scientific articles on experimental asset markets. Almost all of them use a short and definite horizon. This may be one of the starkest differences between experimental settings and real-world financial markets, which usually have indefinite and comparatively long horizons. We analyze the implications of different end time assumptions in an asset market experiment in which we vary the length of the horizon and whether the end time is definite or indefinite. We find very similar price dynamics with recurring bubbles in all treatments.

Trading and cognition in asset markets: An eye-tracking experiment

We use an experimental asset market with eye-tracker measurements for a novel exploration of the cognitive validity of a classic heterogeneous trader taxonomy. Following a top-down approach, we assume that the patterns of information acquisition are governed by one of the three trading strategies, either feedback, passive, or speculative. In line with our first hypothesis, speculators seek information about market expectations. Notwithstanding the two other hypotheses, feedback traders reveal patterns of information acquisition that could ex ante be expected from passive traders, and vice versa.

A Study of Uncertainty & Expectations in Asset Markets

This paper comprehensively examines the impact of expectations and uncertainty on asset market dynamics, with a particular focus on the role of conformity, momentum effects, and strategic uncertainty in shaping market participants' behavior and influencing asset prices and trading volumes. Drawing upon the existing literature, the paper critically reviews the role of these factors in contributing to market inefficiencies, volatility, and potential instability. Acknowledging the limitations of laboratory settings and the challenges in controlling for cognitive factors, such as players' perceptions of their opponents' rationality, the study aims to provide a deeper understanding of the dynamics of mispricing in asset market experiments. Furthermore, the paper discusses the importance of considering psychological factors, such as reversal and momentum effects, when analyzing financial market dynamics and investor decision-making. By proposing a new experiment that addresses the questions raised in the literature, this paper seeks to advance our knowledge of the critical factors influencing investor decision-making in the face of uncertainty, the factors that contribute to mispricing in asset markets, and the importance of public knowledge in shaping market outcomes. The insights gleaned from this research contribute significantly to our understanding of uncertainty and expectations in asset markets and have important implications for market participants, policymakers, and researchers seeking to foster greater stability and efficiency in financial markets.

Risk aversion and information aggregation in binary‐asset markets

We investigate how risk aversion (RA) shapes the informative content of prices in an experimental asset market, where traders are sorted according to their RA. RA should induce steeper individual demands and, under its most common parametrizations, drive equilibrium prices closer to revealing the state. Results support the prediction on individual demands, but not the prediction on prices, which do not vary with RA and are close to the risk‐neutral benchmark. This purported conflict is due to traders, particularly the more risk‐averse ones, conveying into prices only part of their information.

Automated Market Maker vs Continuous Double Auction: An Asset Market Experiment

Automated Market Maker vs Continuous Double Auction: An Asset Market Experiment

Information Processing in an Asset Market Experiment with Algorithmic Arbitrage Trading

Information Processing in an Asset Market Experiment with Algorithmic Arbitrage Trading

Debiasing the Disposition Effect with Noninvasive Brain Stimulation: The Role of Cognitive Control

This study tests whether modulating a brain region associated with cognitive control using noninvasive brain stimulation affects the disposition effect. A participant trades stocks in an experimental asset market while their level of cognitive control is exogenously manipulated by applying weak current stimulation to a control-related cortical region. We find that the stimulation significantly affects the participant’s cognitive control and tendency to exhibit the disposition effect. This result is also obtained for financial professionals. We thus provide evidence that cognitive control is important for the disposition effect. This paper was accepted by Bruno Biais, finance. Funding: X. Niu acknowledges financial support from the National Natural Science Foundation of China [Grant 72203132], Taishan Scholar Program of Shandong Province [Grant tsqn201909013], and Natural Science Foundation of Shandong Province [Grant ZR2022QG048]. J. Li acknowledges financial support from the National Social Science Foundation of China [Grant 20AZD044], Natural Science Foundation of Shandong Province [Grant ZR2022MG068], and Project of Humanities and Social Sciences of Shandong University [Grant 21RWZD15]. Q. Cao acknowledges financial support from the Social Science Foundation of Jiangsu Province [Grant 21GLC006]. The authors also acknowledge financial support from the Major Project of the National Natural Science Foundation of China [Grant 72192842]. Supplemental Material: The data files and online appendix are available at https://doi.org/10.1287/mnsc.2022.4596 .

Informational Price Cascades and Non-Aggregation of Asymmetric Information in Experimental Asset Markets

We report on experimental markets which generate an abject failure of the aggregation of asymmetric information. While realized prices have zero correlation with fundamental values, surprisingly, these are not highly volatile. The non-aggregation of information manifests as prices which lock into home grown norms that we call informational price cascades. Our results are in stark contrast to previous experiments testing fully revealing rational expectations equilibrium under asymmetric information and others examining social learning in asset markets when there is a rational market maker. Our experiments incorporate the asset and information structures from the latter into the decentralized private information setting and double auction trading mechanism of the former. Information only starts to aggregate when either each private signal is revealed to half of the traders, or all private signals are simultaneously released early in the asset’s issue.

Incentive schemes, framing, and market behaviour: Evidence from an asset-market experiment

We investigate how asset prices and trading behaviour are impacted by the structure and framing of incentives, using a lab experiment. Subjects buy and sell a high-risk asset, a low-risk asset, and riskless cash over 10 rounds. We vary, between-subjects, the incentive scheme (relative versus absolute performance), and how the variable component of incentives is framed (bonus versus penalty), while holding constant the convexity of incentives. Both relative-performance (tournament) incentives and penalty framing are associated with significant increases in the price of the high-risk asset, relative to either its fundamental value or to the price of the low-risk asset. Additional analysis shows significant gender differences in trading behaviour and performance, and evidence that the two may be connected.

The Role of the End Time in Experimental Asset Markets

The Role of the End Time in Experimental Asset Markets

Sharing idiosyncratic risk even though prices are “wrong”

We design an infinite-horizon dynamic asset market experiment with perishable consumption and a long-lived asset where gains from trade originate from individuals experiencing idiosyncratic income shocks. Our study is based on the consumption-based general equilibrium theory (Lucas (1978)). The presence of traders having induced motive to smooth consumption is not sufficient to eliminate price bubbles. Despite the asset being consistently priced higher than the equilibrium price, traders are able to share idiosyncratic risk and attain higher welfare. The co-existence of traders with income shocks along with those having no induced motive to trade does not hinder in the former smoothing their consumption stream. Our results hold for markets with and without aggregate risk.

Asset market bubbles in an experiment with sequential information releases

PurposeMuch of the author’s understanding of experimental asset market bubbles is based on the Smith, Suchanek and Williams (SSW) design. The purpose of this paper is to find alternative bubble-producing designs, which is a promising path for new insights.Design/methodology/approachThe Smith et al. (1988) experimental design has been widely used to study bubbles. This paper introduces a novel modification, where the asset has a binary liquidation value and no dividends. Dividends are replaced by the events affecting the liquidation value probability distribution.FindingsOverpricing is common and consistent with subject optimism concerning the random liquidation value. Bubbles are also observed, as the degree of overpricing often rises and then fall during the experiments. However, crashes where the asset price drops below fundamental values are not observed.Research limitations/implicationsSubject over optimism, speculation and/or subject confusion are possible bubble ingredients. More research is needed to determine how much the factors responsible for these bubbles differ from the factors responsible for the SSW design. However, it seems likely that there are at least some common factors given the structural similarities between the two designs.Originality/valueThe present design is novel and may provide a means to better generalize results from previous experiments based on the SSW design.

Single vs. multiple disclosures in an experimental asset market with information acquisition

We conduct laboratory experiments to study whether increasing the number of independent public signals in an economy with endogenous private information is an effective measure to promote the acquisition of information and to enhance price efficiency. We observe that the release of public information crowds out the traders' demand for private information under a single disclosure while favoring private information acquisition under multiple disclosures. The latter measure improves price accuracy in forecasting the asset fundamental value. However, multiple disclosures do not eliminate the adverse effect of market overreaction to public information, becoming a potential source of fragility for the financial system.

Capital constraints and asset bubbles: An experimental study

Abstract This paper evaluates the effects of credit constraints in an asset market experiment with present value considerations induced by interest payments on cash. All markets exhibit price bubbles, with peak prices exceeding the present value of dividends and redemptions by 30–130%. Starting with a baseline condition (low income, tight credit), a relaxation of credit constraints generates significantly higher price bubbles. A price increase of similar magnitude results from an increase in exogenous income, holding credit tightness constant.

The Role of the End Time in Experimental Asset Markets

By now there are hundreds of scientific articles on experimental asset markets. Almost all of these experiments use a short and definite horizon. This may be one of the starkest differences to financial asset markets outside the laboratory, which usually have indefinite and comparatively long horizons. We analyze the role of the end time in an asset market experiment in which we vary the length of the horizon and whether the end time is definite or indefinite. We find recurring bubbles and similar price dynamics in all treatments (with moderately lower prices in the treatments with a long horizon).

The Effect of Ambiguity on Price Formation and Trading Behavior in Financial Markets

This paper sets up an experimental asset market in the laboratory to investigate the effects of ambiguity on price formation and trading behavior in financial markets. The obtained trading data is used to analyze the effect of ambiguity on various market outcomes (the price level, volatility, trading activity, market liquidity, and the degree of speculative trading) and to test the quality of popular empirical market-based measures for the degree of ambiguity. We find that ambiguity decreases market prices and trading activity; ambiguity leads to lower market liquidity through wider bid-ask spreads; and ambiguity leads to less speculative trading. We also find that popular market-based measures of ambiguity used in the empirical literature do not seem to correctly capture the true degree of ambiguity.

Supplemental Material for Greed and Individual Trading Behavior in Experimental Asset Markets

Supplemental Material for Greed and Individual Trading Behavior in Experimental Asset Markets

A Culture of Greed: The Effect of Aggregate Greed on Bubble Formation in Experimental Asset Markets

We investigate the relation between the motive of greed and several asset market indicators such as trading activity and bubble formation in the form of mispricing, overpricing, and price amplitude. To that end, we run experiments in which we are able to measure individuals’ greed and create markets populated with greedy and markets with non-greedy investors. High-greed markets exhibited less frequent and smaller price bubbles than markets with less greedy traders. As for trading activity, we find only small evidence of greedier individuals showing higher trading activity. If our findings translate to actual markets, our findings suggest that, contrary to common suggestions, greed might not contribute negatively to the emergence of financial crises.

The Effect of Transaction Cost Unbundling on Investors' Reliance on Investment Research: Evidence from Experimental Asset Markets

Recent regulatory changes within Europe (regulation MiFID II) mandate broker-dealers to charge clients explicitly for any investment research they provide. This new mandate replaces the common practice of bundling these charges with other variable fees, such as those for trade executions. Drawing on transaction decoupling theory, I examine how transaction cost unbundling influences investors’ reliance on investment research. Results from 16 experimental markets indicate that investors place greater weight on costly forecasts under a system of unbundled payments compared to bundled payments, but only if transaction costs are sufficiently high to provoke feelings of regret. Focusing on the forecast, investors also cede to reduce price errors over time. Additional analysis suggests that salient cost disclosure, a more cost-effective way to generate transparent transaction costs, does not similarly impact investor judgment. These results are important in light of recent SEC discussions on how to respond to Europe’s regulatory push for cost transparency.