We experimentally explore how investor decision horizons influence the formation of stock prices. We find that in long-horizon sessions, where investors collect dividends till maturity, prices converge to the fundamental levels derived from dividends through backward induction. In short-horizon sessions, where investors exit the market by receiving the price (not dividends), prices levels and paths become indeterminate and lose dividend anchors; investors tend to form their expectations of future prices by forward, not backward, induction. These laboratory results suggest that investors' short horizons and the consequent difficulty of backward induction are important contributors to the emergence of price bubbles.
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Paper provided by Institute of Social and Economic Research, Osaka University in its series ISER Discussion Paper with number
0634.
References listed on IDEAS Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
Dow, James & Gorton, Gary, 1994.
" Arbitrage Chains,"
Journal of Finance,
American Finance Association, vol. 49(3), pages 819-49, July.
[Downloadable!] (restricted)
Other versions:
James Dow & Gary Gorton, 1993.
"Arbitrage Chains,"
NBER Working Papers
4314, National Bureau of Economic Research, Inc.
[Downloadable!] (restricted)
James Dow & Gary Gorton, 1993.
"Arbitrage Chains,"
CEPR Financial Markets Paper
0035, European Science Foundation Network in Financial Markets, c/o C.E.P.R, 53--56 Great Sutton Street, London EC1V 0DG.
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