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Expectation Driven Price Volatility in an Experimental Cobweb Economy

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Author Info

  • Hommes, C.H.

    ()
    (Universiteit van Amsterdam)

  • Sonnemans, J.

    ()
    (Universiteit van Amsterdam)

  • Tuinstra, J.

    ()
    (Universiteit van Amsterdam)

  • van de Velden, H.

    (Universiteit van Amsterdam)

Abstract

The purpose of this paper is to investigate expectation formation in a controlled experimental environment. Subjects are asked to predict next periods price in an unknown, unstable nonlinear cobweb economy with expectational feedback. Subjects have no information about underlying market equilibrium equations, but can learn by observing past price realizations and predictions. We conduct both single-agent and multi-agent experiments. In the multi-agent experiments forecasting errors were lower and average earnings were higher than in the single-agent experiments. In both the single and multi-agent experiments in most cases convergence in the mean to rational expectations (RE) occurs. Typically, the null hypothesis that the sample mean of realized prices is different from the RE steady state cannot be rejected. However, prices do not converge to the RE steady state but keep fluctuating irregularly. In fact, almost all experiments exhibit strongly significant excess price volatility driven by endogenous expectations.

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Bibliographic Info

Paper provided by Universiteit van Amsterdam, Center for Nonlinear Dynamics in Economics and Finance in its series CeNDEF Working Papers with number 99-07.

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Date of creation: 1999
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Handle: RePEc:ams:ndfwpp:99-07

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Postal: Dept. of Economics and Econometrics, Universiteit van Amsterdam, Roetersstraat 11, NL - 1018 WB Amsterdam, The Netherlands
Phone: + 31 20 525 52 58
Fax: + 31 20 525 52 83
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Web page: http://www.fee.uva.nl/cendef/
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Cited by:
  1. Frank H. Westerhoff, 2001. "Expectations Driven Distortions in the Foreign Exchange Market," Computing in Economics and Finance 2001 48, Society for Computational Economics.
  2. Brock,W.A. & Hommes,C.H., 2001. "Evolutionary dynamics in financial markets with many trader types," Working papers 7, Wisconsin Madison - Social Systems.
  3. Sonnemans, Joep & Hommes, Cars & Tuinstra, Jan & van de Velden, Henk, 2004. "The instability of a heterogeneous cobweb economy: a strategy experiment on expectation formation," Journal of Economic Behavior & Organization, Elsevier, vol. 54(4), pages 453-481, August.

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