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Do Option-like Incentives Induce Overvaluation? Evidence from Experimental Asset Markets

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  • Holmén, Martin

    ()
    (Department of Economics, School of Business, Economics and Law, Göteborg University)

  • Kirchler, Michael

    ()
    (University of Innsbruck and University of Gothenburg)

  • Kleinlercher, Daniel

    ()
    (University of Innsbruck)

Abstract

One potential reason for bubbles evolving prior to the financial crisis was excessive risk taking stemming from option-like incentive schemes in financial institutions. By running laboratory asset markets, we investigate the impact of option-like incentives on price formation and trading behavior. We observe (i) that option-like incentives induce significantly higher market prices than linear incentives. We further find that (ii) option-like incentives provoke subjects to behave differently and to take more risk than subjects with linear incentives. We finally show that (iii) trading at inflated prices is rational for subjects with option-like incentives since it increases their expected payout.

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File URL: http://hdl.handle.net/2077/30294
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Bibliographic Info

Paper provided by University of Gothenburg, Department of Economics in its series Working Papers in Economics with number 540.

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Length: 38 pages
Date of creation: 18 Sep 2012
Date of revision: 21 Nov 2012
Handle: RePEc:hhs:gunwpe:0540

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Postal: Department of Economics, School of Business, Economics and Law, University of Gothenburg, Box 640, SE 405 30 GÖTEBORG, Sweden
Phone: 031-773 10 00
Web page: http://www.handels.gu.se/econ/
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Keywords: mispricing; incentives; market efficiency; experimental finance;

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