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Thar She Bursts: Reducing Confusion Reduces Bubbles

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  • Michael Kirchler
  • Jurgen Huber
  • Thomas Stockl
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    Abstract

    To explore why bubbles frequently emerge in the experimental asset market model of Smith, Suchanek, and Williams (1988), we vary the fundamental value process (constant or declining) and the cash-to-asset value ratio (constant or increasing). We observe high mispricing in treatments with a declining fundamental value, while overvaluation emerges when coupled with an increasing C/A ratio. A questionnaire reveals that the declining fundamental value process confuses subjects, as they expect the fundamental value to stay constant. Running the experiment with a different context ("stocks of a depletable gold mine" instead of "stocks") significantly reduces mispricing and overvaluation as it reduces confusion. (JEL C91, D14, G11, G12)

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    File URL: http://www.aeaweb.org/articles.php?doi=10.1257/aer.102.2.865
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    Bibliographic Info

    Article provided by American Economic Association in its journal American Economic Review.

    Volume (Year): 102 (2012)
    Issue (Month): 2 (April)
    Pages: 865-83

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    Handle: RePEc:aea:aecrev:v:102:y:2012:i:2:p:865-83

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    1. Fama, Eugene F, 1970. "Efficient Capital Markets: A Review of Theory and Empirical Work," Journal of Finance, American Finance Association, vol. 25(2), pages 383-417, May.
    2. Martin Dufwenberg & Tobias Lindqvist & Evan Moore, 2005. "Bubbles and Experience: An Experiment," American Economic Review, American Economic Association, vol. 95(5), pages 1731-1737, December.
    3. Urs Fischbacher, 2007. "z-Tree: Zurich toolbox for ready-made economic experiments," Experimental Economics, Springer, vol. 10(2), pages 171-178, June.
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