Asset Markets with OLGBEM 2012

8. 6. 2012, Bratislava

Prices in economics

– Markets and prices are a critical feature of economies (Coase, 1937)

– Market prices serve as signals, coordinating the activities of dispersed individuals with dispersed knowledge (Hayek, 1945)

– Markets are theoretically rational if prices reflect all available information (Muth, 1961)

– Above mentioned qualities well demonstrated by experiments (Smith at al., 1956 and on)

Canonical AM experiments

– Asset market prices have become unhinged from the fundamental value, sometimes for extended periods (with negative effects propagated through the whole economy when the market corrects)

– Supported by experimental evidence (Smith, Suchanek, Williams, 1988 and on)

– There are hundreds of laboratory experiments replicating and extending the results of SSW

Bubbles at AM experiments

– Bubble: “persistent deviations of prices from fundamentals” at high volumes of trade (Haruvy and Noussair, 2006)

Robustness of AM experiments

– Short selling, margin buying, limit price-change rules, insider trading and increasing levels of subject experience (King et al., 1993, Van Boening, Williams, and LaMaster, 1993)

– Constant fundamental value (Bostian, Goeree and Holt, 2005)

– Futures contracting and dividend uncertainty (Porter and Smith, 1995)

– No dividends (Oechssler, Schmidt and Schnedler, 2007)

Summary of AM experiments

– more than 20 years of follow-up research, the incidence of asset market bubbles identified in the original paper by Smith et al. (1988) still holds almost regardless of the circumstances, with the only exception being super-experienced traders. Experimental asset markets appear to be prone to bubble creation.

„Flaws“ of canonical setting

– All AM experiment suffer two fundamental „flaws“ – EoW and „inflation“

– the end of the world” (EoW) is highly unrealistic in fundamental way = it is more than the end of trading. It is the common knowledge that there is no activity after that particular moment for anyone

– „inflation“ – increasing amount of money in the experiment

Smith-Porter-Deck project (2011)

– Introduce OLG setting – However, new generation brings new liquidity

to the market

Design I

– 4 generations (each generation 9 subejcts)– Life time of the generation: average 10 periods– Some members „die“ earlier than others– Redemption value for Asset at the end of

trading (100)– New entrants „step into shoes“ of dying ones– There is no link between different generations– Average dividend: 5 (min: 0, max 12, randomly

drawn)

Design II

– Interest rate on money: 5 %– Initial endowment: 3 shares and 300 EUs– Redemption value for exiting subjects – market

value of the share plus discounted value of the money

– Institution: double auction market with multiple subjects

Pilot experiments

– 3 generations– 2 groups (24 people each) – UEP and WVU

students– 1 generation = 8 people– 30 periods of trading– No experience with AM experiments before– Paid by „points“– March 2012

Pilot experiments - results

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 300

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Generation change Avprice - pilot UEPAvprice - pilot WVU Fundamental value

Real life – the case of the Czech capital market

07-Sep-93

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07-Jun-95

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04-Aug-95

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PX norm. 1993 - 1995

Experiments

– 4 generations– 2 groups (32 people each) – UEP students– 1 generation = 8 people– 40 periods of trading– No experience with AM experiments before– Paid by real money– Average earnings 550 CZK / 22 EUR– May 2012

Experiments - results

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 400

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Generation change Avprice - May 4 Avprice - May 5 Fundamental value

Experiments - interpretation

– So far INCONCLUSIVE!– No bubbles with the generational switch – if

anything prices go DOWN!– There is a volatility that appears to be a long

sustained bubble (with exception of the last generation perhaps)

– Smith, Porter Deck results are due to additional liquitidy – not due to generational switch

Experiments – other treatments

– „Sudden“ generational switch– No inflation treatment– Continuous change

– Time: June 2012

– Thanks for financing: Liberalni institute and IGS UEL

Thank you for your attention