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Effect of uncertainty about others’ rationality in experimental asset markets

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Abstract

We investigate the extent to which price deviations from fundamental values in an experimental asset market are due to the uncertainty of subjects regarding others’ rationality. We do so by comparing the price forecasts submitted by subjects in two market environments: (a) all six traders are human subjects (6H), and (b) one human subject interacts with five profit-maximizing computer traders who assume all the traders are also maximizing profit (1H5C). The subjects are told explicitly about the behavioral assumption of the computer traders (in both 6H and 1H5C) as well as which environment they are in. Results from our experiments show that there is no significant difference between the distributions of the initial deviations of the forecast prices from the fundamental values in the two markets. However, as subjects learn by observing the realized prices, the magnitude of deviations becomes significantly smaller in 1H5C than in 6H markets. We also conduct additional experiments where subjects who have experienced the 1H5C market interact with five inexperienced subjects. The price forecasts initially submitted by the experienced subjects follow the fundamental value despite the fact that the subjects are explicitly told that the five other traders in the market are inexperienced subjects. These findings do not support the hypothesis that uncertainty about others’ rationality plays a major role in causing substantial deviation of forecast prices from the fundamental values in these asset market experiments.

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Bibliographic Info

Paper provided by Aix-Marseille School of Economics, Marseille, France in its series AMSE Working Papers with number 1234.

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Length: 26 pages
Date of creation: 19 Nov 2012
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Handle: RePEc:aim:wpaimx:1234

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Web page: http://www.amse-aixmarseille.fr/en
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Keywords: Rationality; Common knowledge; Experiment; Asset Markets; Computer Traders.;

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  1. Bao, T. & Hommes, C.H. & Sonnemans, J. & Tuinstra, J., 2010. "Individual Expectations, Limited Rationality and Aggregate Outcomes," CeNDEF Working Papers 10-07, Universiteit van Amsterdam, Center for Nonlinear Dynamics in Economics and Finance.
  2. Mikhail Anufriev & Cars Hommes, 2012. "Evolutionary Selection of Individual Expectations and Aggregate Outcomes in Asset Pricing Experiments," American Economic Journal: Microeconomics, American Economic Association, American Economic Association, vol. 4(4), pages 35-64, November.
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  7. Heemeijer, Peter & Hommes, Cars & Sonnemans, Joep & Tuinstra, Jan, 2009. "Price stability and volatility in markets with positive and negative expectations feedback: An experimental investigation," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 33(5), pages 1052-1072, May.
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Cited by:
  1. John Duffy & Te Bao, 2013. "Adaptive vs. Eductive Learning: Theory and Evidence," Working Papers, University of Pittsburgh, Department of Economics 518, University of Pittsburgh, Department of Economics, revised Dec 2013.
  2. Eizo Akiyama & Nobuyuki Hanaki & Ryuichiro Ishikawa, 2013. "How Do Experienced Traders Respond to Inflows of Inexperienced Traders? An Experimental Analysis," AMSE Working Papers 1359, Aix-Marseille School of Economics, Marseille, France, revised 18 Dec 2013.
  3. Eizo Akiyama & Nobuyuki Hanaki & Ryuichiro Ishikawa, 2013. "It is Not Just Confusion! Strategic Uncertainty in an Experimental Asset Market," AMSE Working Papers 1340, Aix-Marseille School of Economics, Marseille, France, revised 08 Aug 2013.
  4. Nobuyuki Hanaki & Nicolas Jacquemet & Stéphane Luchini & Adam Zylbersztejn, 2013. "Bounded Rationality and Strategic Uncertainty in a Simple Dominance Solvable Game," Economics Discussion / Working Papers, The University of Western Australia, Department of Economics 13-14, The University of Western Australia, Department of Economics.
  5. Bao, T. & Hommes, C.H. & Makarewicz, T.A., 2014. "Bubble Formation and (In)efficient Markets in Learning-to-Forecast and -Optimize Experiments," CeNDEF Working Papers 14-01, Universiteit van Amsterdam, Center for Nonlinear Dynamics in Economics and Finance.

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