Fundamental Price Research Articles

Bubble Formation and (In)Efficient Markets in Learning-to-Forecast and -Optimise Experiments

This experiment compares the price dynamics and bubble formation in an asset market with a price adjustment rule in three treatments where subjects (1) submit a price forecast only, (2) choose quantity to buy/sell and (3) perform both tasks. We find deviation of the market price from the fundamental price in all treatments, but to a larger degree in treatments (2) and (3). Mispricing is therefore a robust finding in markets with positive expectation feedback. Some very large, recurring bubbles arise, where the price is 3 times larger than the fundamental value, which were not seen in former experiments.

An Experimental Analysis of Information Acquisition in Prediction Markets

We study which factors in terms of trading environment and trader characteristics determine individual information acquisition in experimental asset markets. Traders with larger endowments, existing inconclusive information, lower risk aversion, and less experience in financial markets tend to acquire more information. Overall, we find that traders overacquire information, so that informed traders on average obtain negative profits net of information costs. Information acquisition and the associated losses do not diminish over time. This overacquisition phenomenon is inconsistent with predictions of rational expectations equilibrium, and we argue it resembles the overdissipation results from the contest literature. We find that more acquired information in the market leads to smaller differences between fundamental asset values and prices. Thus, the overacquisition phenomenon is a novel explanation for the high forecasting accuracy of prediction markets.

Rational Bubble on Interest-Bearing Assets

This paper compares fiat money and a Lucas' tree in an overlap- ping generations model. A Lucas' tree with a positive dividend has a unique competitive equilibrium price. Moreover, the price converges to the monetary equilibrium value of fiat money as the dividend goes to zero in the limit. Thus, the value of liquidity represented by a ra- tional bubble is part of the fundamental price of a standard interest- bearing asset. A Lucas' tree has multiple equilibrium prices if the dividend vanishes permanently with some probability. This case may be applicable to public debt, but not to stock or urban real estate.

Exploring the WTI crude oil price bubble process using the Markov regime switching model

The sharp volatility of West Texas Intermediate (WTI) crude oil price in the past decade triggers us to investigate the price bubbles and their evolving process. Empirical results indicate that the fundamental price of WTI crude oil appears relatively more stable than that of the market-trading price, which verifies the existence of oil price bubbles during the sample period. Besides, by allowing the WTI crude oil price bubble process to switch between two states (regimes) according to a first-order Markov chain, we are able to statistically discriminate upheaval from stable states in the crude oil price bubble process; and in most of time, the stable state dominates the WTI crude oil price bubbles while the upheaval state usually proves short-lived and accompanies unexpected market events.

Public Messages and Asset Prices

We analyze the potential role of a public message as a coordination mechanism between traders in an experimental asset market that exhibits departures from fundamental values. Dividends are the same for all players except for an unknown ex-ante. During the treatment sessions, a message that does not offer new information is sent to all traders at the same predetermined time. We compare deviations from fundamental prices in sessions with and without a message. We find no statistical evidence that a public message without informational content is able to bring prices back to fundamental values.

Error correction dynamics of house prices: An equilibrium benchmark

Central to recent debates on the “mis-pricing” in the housing market and the proactive policy of central bank is the determination of the “fundamental house price.” This paper builds a dynamic stochastic general equilibrium (DSGE) model that produces reduced-form dynamics that are consistent with the error-correction models proposed by Malpezzi (1999) and Capozza et al. (2004). The dynamics of equilibrium house prices are tied to the dynamics of the house-price-to-income ratio. This paper also shows that house prices and incomes should be co-integrated, and hence provides a justification of using co-integration tests to detect possible “mis-pricing” in the housing market.

Which Protocol? Mutual Interaction of Heterogeneous Congestion Controllers

A large number of congestion control protocols have been proposed in the last few years, with all having the same purpose—to divide available bandwidth resources among different flows in a fair manner. Each protocol operates on the paradigm of some conception of link price (such as packet losses or packet delays) that determines source transmission rates. Recent work on network utility maximization has brought forth the idea that the fundamental price or Lagrange multiplier for a link is proportional to the queue length at that link, and that different congestion metrics (such as delays or drops) are essentially ways of interpreting such a Lagrange multiplier. We thus ask the following question: Suppose that each flow has a number of congestion control protocols to choose from, which one (or combination) should it choose? We introduce a framework wherein each flow has a utility that depends on throughput and also has a disutility that is some function of the queue lengths encountered along the route taken. Flows must choose a combination of protocols that would maximize their payoffs. We study both the socially optimal, as well as the selfish cases to determine the loss of system-wide value incurred through selfish decision making, so characterizing the “price of heterogeneity.” We also propose tolling schemes that incentivize flows to choose one of several different virtual networks catering to particular needs and show that the total system value is greater, hence making a case for the adoption of such virtual networks.

Oscillatory Dynamics in a Continuous-Time Delay Asset Price Model with Dynamical Fundamental Price

Based on the seminal work of He and Li (J Econ Dyn Cont 36:973---987, 2012) on a financial market of heterogeneous beliefs and adaptive behavior, we further propose a model of five dimensional differential delay equations with time varying fundamental price. It is shown that not only the rational behavior of heterogeneous agents routes, but also the fluctuant fundamental price to market instability in continuous time. Oscillatory dynamics of the model are studied by analyzing the associated characteristic equation of the delay differential system. Numerical simulations indicate that the fluctuant fundamental price can obviously increases the financial market amplitude of vibration.

Identifying Booms and Busts in House Prices Under Heterogeneous Expectations

We introduce heterogeneous expectations in a standard housing market model linking housing rental levels to fundamental buying prices. Using quarterly data we estimate the model parameters for eight different countries, US, UK, NL, JP, CH, ES, SE and BE. We find that the data support heterogeneity in expectations, with temporary endogenous switching between fundamental mean-reverting and trend-following chartists beliefs based on their relative performance. For all countries we identify temporary house price bubbles, amplified by trend extrapolation, and crashes reinforced by fundamentalists. The qualitative predictions of such non-linear models are very different from standard linear benchmarks, with important policy implications. The fundamental price becomes unstable, e.g. when the interest rate is set too low or mortgage tax deductions too high, giving rise to multiple non-fundamental equilibria and/or global instability.

Identifying Booms and Busts in House Prices Under Heterogeneous Expectations

We introduce heterogeneous expectations in a standard housing market model linking housing rental levels to fundamental buying prices. Using quarterly data we estimate the model parameters for eight different countries, US, UK, NL, JP, CH, ES, SE and BE. We find that the data support heterogeneity in expectations, with temporary endogenous switching between fundamental mean-reverting and trend-following chartists beliefs based on their relative performance. For all countries we identify temporary house price bubbles, amplified by trend extrapolation, and crashes reinforced by fundamentalists. The qualitative predictions of such non-linear models are very different from standard linear benchmarks, with important policy implications. The fundamental price becomes unstable, e.g. when the interest rate is set too low or mortgage tax deductions too high, giving rise to multiple non-fundamental equilibria and/or global instability.

Disposition Effect in an Agent-based Financial Market Model

Disposition effect, which refers to investors’ being reluctant to realize losses, is very common in financial markets, especially in mainland China. This paper introduces the disposition effect into a multi-agent model, to research investor behavior and its impact on financial markets. As the result of computer simulation, disposition effect reveals asymmetric volatility which reflects the actual situation in mainland China market, i.e. the impact of bad news on volatility is greater than the impact of good news of the same magnitude. Sensitivity analysis shows that investors’ disposition behaviour slows the release rate of news, makes market more stable around the fundamental price. Meanwhile, proper level of disposition effect can avoid some loss in investment, and make chartist get relative higher return than usual. These conclusions could hopefully offer insights and effective support for investment decision-making and policy regulation.

Error Correction Dynamics of House Prices: An Equilibrium Benchmark

Central to recent debates on the mis-pricing in the housing market and the proactive policy of central bank is the determination of the fundamental house price. This paper builds a dynamic stochastic general equilibrium (DSGE) model that produces reduced-form dynamics that are consistent with the error-correction models proposed by Malpezzi (1999) and Capozza et al (2004). The dynamics of equilibrium house prices are tied to the dynamics of the house-price-to-income ratio. This paper also shows that house prices and incomes should be co-integrated, and hence provides a justification of using co-integration tests to detect possible mis-pricing in the housing market.

Commodity futures and market efficiency

We analyze the market efficiency of 25 commodity futures across various groups—metals, energies, soft commodities, grains and other agricultural commodities. To do so, we utilize the recently proposed Efficiency Index to find out that the most efficient among all of the analyzed commodities is heating oil, closely followed by WTI crude oil, cotton, wheat, and coffee. On the other end of the ranking scale we find live cattle and feeder cattle. The efficiency is also found to be characteristic for specific groups of commodities, with energy commodities being the most efficient and other agricultural commodities (composed mainly of livestock) the least efficient groups. We also discuss contributions of long-term memory, fractal dimension and approximate entropy to the total inefficiency. Last but not least, we come across the nonstandard relationship between the fractal dimension and the Hurst exponent. For the analyzed dataset, the relationship between these two variables is positive, meaning that local persistence (trending) is connected to global anti-persistence. We attribute this behavior to specifics of commodity futures: they may be predictable over a short term and locally, but over a long term they return to their fundamental prices.

Effects of Executive Compensation Complexity on Investor Behaviour in an Experimental Stock Market

This study experimentally investigates whether shareholders correctly anticipate the incentive effects of increasingly complex compensation packages given to managers, and whether potential biases in individual shareholder beliefs carry over to price and volume effects in a stock market. In the experiment, a manager makes a decision about the stochastic dividend process generating the firm's fundamental value, and shareholders make estimations about fundamental value and trade shares in a stock market. The manager's action is either known or hidden and, nested in the hidden-action condition, compensation is either simple or complex. We hypothesise that hidden action gives rise to perceived behavioural uncertainty, and that this uncertainty has valuation relevance in that it affects both individual estimations of fundamental firm value and stock prices. Furthermore, we hypothesise that perceived behavioural uncertainty increases with the complexity of compensation, and that compensation complexity also affects trading volume. We find supporting evidence for our conjectures. Both estimations and market prices are biased when the manager's action is hidden, and biases are stronger when compensation is complex. We further find that trading volume decreases when compensation is complex, even though the heterogeneity of investors' individual beliefs increases.

Optimal Accelerated Share Repurchase

An accelerated share repurchase (ASR) allows a firm to repurchase a significant portion of its shares immediately, while shifting the burden of reducing the impact and uncertainty in the trade to an intermediary. The intermediary must then purchase the shares from the market over several days, weeks, or as much as several months. Some contracts allow the intermediary to specify when the repurchase ends, at which point the corporation and the intermediary exchange the difference between the arrival price and the TWAP over the trading period plus a spread. Hence, the intermediary effectively has an American option embedded within an optimal execution problem. As a result, the firm receives a discounted spread relative to the no early exercise case. In this work, we address the intermediary's optimal execution and exit strategy taking into account the impact that trading has on the market. We demonstrate that it is optimal to exercise when the TWAP exceeds &#918(t) St where St is the fundamental price of the asset and &#918(t) is deterministic. Moreover, we develop a dimensional reduction of the stochastic control and stopping problem and implement an efficient numerical scheme to compute the optimal trading and exit strategies.

The effect of rating agencies on herd behaviour

This paper purports to provide some evidence on the effect of rating agencies in financial markets. By means of a laboratory experiment, we investigate the effect and interaction between private and public information. We reached two conclusions: (1) indeed, the rating agency can speed up price convergence, (2) but not always to the fundamental price.

Aftermath of the VAT fraud on carbon emissions markets

PurposeThe purpose of this paper is to recognize the effect of the VAT fraud upon the market prices and to assess the occurrence of money laundering on the carbon emissions market. The paper presents an analytic breakdown of the MTIC pocketed funds and estimates the bearish impact of the VAT trade on the carbon prices. The VAT carousel could also be used for all the steps of money laundering given the lack of control and surveillance of various trading firms.Design/methodology/approachIn a previous work by Frunza and Guégan it was shown that the European carbon market is strongly influenced by fundamentals factors such as oil, energy, gas, coal and equities. Using public market prices and volumes for both futures and spot exchanges, the model allows us to assess and quantify the spread between the observed carbon prices and the theoretical fundamental prices. The dataset analysis reveals that the spot volumes remained abnormally high compared to an empirical economic level, even after the end of the VAT fraud on the organised exchange. These abnormal volumes could be explained by the occurrence of speculative trading linked to the money laundering.FindingsFindings present an analytic breakdown of the MTIC pocketed funds and a bearish impact of 2‐3 euros upon the carbon prices. The paper also explains the origin of a relative persistence of high volumes on the spot market by proposing a model of placement, layering and integration steps on the carbon emissions market, similar to the VAT carousel.Originality/valueThis paper is the first study that quantifies the market manipulation effect due to VAT fraud. The work is also unique as it provides the first estimation of money laundered on the carbon emission market.

Fórmula de valoração racional (RVF) e variabilidade no tempo das taxas de retornos de ativos

O relacionamento de longo prazo e o correspondente mecanismo de correção de erros no curto prazo, entre dados agregados de preço e dividendos, é estudado no presente trabalho, através dos conceitos de fórmula de valoração racional e cointegração variante no tempo, e sob o referencial da teoria das expectativas racionais e de movimentação de preços de Muth (1961), para se supor a variabilidade das taxas de retorno de ativos, testando as hipóteses nulas de mecanismos de correção de erros dos vetores de cointegração constantes no tempo e de desigualdade entre valor fundamental e preço da ação. As séries obtidas foram as disponibilizadas por Shiller (2005) e se referem aos dados agregados de preço e dividendos do mercado acionário norte-americano, no período de 1871 a 2010. Os dados foram analisados através dos modelos de cointegração de Johansen, com a utilização de variáveis restritas decorrentes da combinação das variáveis estudadas com o polinômio temporal de Chebyshev, como proposto por Bierens e Martins (2010). Os resultados indicam a rejeição da hipótese nula de constância dos vetores de cointegração e, ainda, a não rejeição da hipótese nula de desigualdade entre valor fundamental e preço da ação. Tais resultados são consistentes com os obtidos por Bierens e Martins (2010) e não consistentes com a teoria das expectativas racionais de Muth (1961). Conclui-se, portanto, que os investidores possuem diferentes expectativas de retorno para diferentes períodos futuros, que os resultados sugerem a validação do modelo utilizado e que existe a possibilidade da ocorrência de movimentos especulativos suportados pela racionalidade ou bolhas especulativas racionais.

Assessing House Prices in Germany: Evidence from an Estimated Stock-Flow Model Using Regional Data

Based on a stock-flow model of the housing market we estimate the relationship of house prices and explanatory macroeconomic variables in Germany using a regional panel dataset for 402 administrative districts. Using regional data exploits the variation across local housing markets and overcomes time-series data limitations. We take the regression residuals as a measure for deviations of actual house prices from their fundamental equilibrium level. The model specification allows to aggregate district-level residuals for various regional subsets. During the past two years for Germany as a whole single-family house prices appeared to be in line with their fundamental equilibrium level, whereas apartment prices significantly exceeded the fundamental price suggested by the model. The overvaluation of apartments is higher in towns and cities and most pronounced in the major seven cities, while single-family houses in cities appear to be only moderately above their fundamental levels.

The influence of herding behaviour on house prices

PurposeA comparison of fundamental house prices with actual prices indicates that house prices fluctuate more than fundamentally justified, a fact difficult to explain with standard rational agent models. The purpose of this paper is to evaluate to what extent herding behaviour among investors can be seen as an explanation for deviations of house prices from their fundamental value.Design/methodology/approachTo see whether house prices fluctuate more than fundamentally justified, the paper calculates a fundamental house price and compares it to the actual price for seven European and three non‐European OECD countries. Then the paper incorporates herding behaviour into the house‐price model and examines its influence on the development of prices.FindingsA comparison of the fundamental house prices with actual prices indicates that house prices fluctuate more than fundamentally justified. The calibration of the herding model indicates that it can help to explain fluctuations of actual house prices.Originality/valueThe incorporation of herding behaviour into a housing model and the calibration of its impact are the main innovations of this paper.