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Expectations Structure in Asset Pricing Experiments

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  • Giulio Bottazzi
  • Maria Giovanna Devetag

Abstract

Notwithstanding the recognized importance of traders expectations incharacterizing the observed market dynamics, for instance theformation of speculative bubbles and crashes on financial markets,little attention has been devoted so far by economists to a rigorousstudy of expectation formation in the laboratory. In this work wedescribe a laboratory experiment on the emergence and coordination ofexpectations in a pure exchange framework. We largely base our studyon previous experiments on expectation formation in a controlledlaboratory environment by Cars Hommes, Joep Sonnemans, Ian Tuinstraand Henk van de Velden (CeNDEF Working Paper, Amsterdam, 2002). Weconsider a simple two asset economy with a riskless bond and a riskystock. Each market is composed of six experimental subjects who act asfinancial advisors of myopic risk-averse utility maximizing investorsand are rewarded according to how well their forecasts perform in themarket. The participants are asked to predict not only the price ofthe risky asset at time t+1, as in Hommes et al., but also theconfidence interval of their prediction, knowing the past realizationsof the price until time t-1. The realized asset price is derived fromaWalrasian market equilibrium equation, unknown to the subjects, withfeedback from individual forecasts. Subjects earnings are proportionalto the increase in their wealth level. With respect to previousexperiments that did not include an explicit evaluation of risk byparticipants, we observe a higher price volatility, a decreasedlikelihood of bubble dynamics and, in general, a higher heterogeneityof predictions.

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Bibliographic Info

Paper provided by Laboratory of Economics and Management (LEM), Sant'Anna School of Advanced Studies, Pisa, Italy in its series LEM Papers Series with number 2003/19.

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Date of creation: 21 Dec 2003
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Handle: RePEc:ssa:lemwps:2003/19

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Keywords: Experimental Economics; Expectations; Coordination; Asset pricing;

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References

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  1. Mark van Boening & Vernon L. Smith & Charissa P. Wellford, 2000. "Dividend timing and behavior in laboratory asset markets," Economic Theory, Springer, vol. 16(3), pages 567-583.
  2. Giulio Bottazzi & Giovanna Devetag, 2005. "Expectations structure in asset pricing experiments," CEEL Working Papers 0503, Cognitive and Experimental Economics Laboratory, Department of Economics, University of Trento, Italia.
  3. Hommes, Cars & Sonnemans, Joep & Tuinstra, Jan & van de Velden, Henk, 2008. "Expectations and bubbles in asset pricing experiments," Journal of Economic Behavior & Organization, Elsevier, vol. 67(1), pages 116-133, July.
  4. Cars Hommes & Joep Sonnemans & Jan Tuinstra & Henk van de Velden, 2003. "Coordination of Expectations in Asset Pricing Experiments," Tinbergen Institute Discussion Papers 03-010/1, Tinbergen Institute.
  5. Sunder, S., 1992. "Experimental Asset Markets: A Survey," GSIA Working Papers 1992-19, Carnegie Mellon University, Tepper School of Business.
  6. Porter, David P & Smith, Vernon L, 1995. "Futures Contracting and Dividend Uncertainty in Experimental Asset Markets," The Journal of Business, University of Chicago Press, vol. 68(4), pages 509-41, October.
  7. Giulio Bottazzi, 2002. "A Simple Micro-Model of Market Dynamics Part I: The "Homogenous Agents" Deterministic Limit," LEM Papers Series 2002/10, Laboratory of Economics and Management (LEM), Sant'Anna School of Advanced Studies, Pisa, Italy.
  8. Smith, Vernon L & Suchanek, Gerry L & Williams, Arlington W, 1988. "Bubbles, Crashes, and Endogenous Expectations in Experimental Spot Asset Markets," Econometrica, Econometric Society, vol. 56(5), pages 1119-51, September.
  9. Noussair, C. & Robin, S. & Ruffieux, B., 1998. "Bubbles and Anti-Crashes in Laboratory Asset Markets with Constant Fundamental Values," Purdue University Economics Working Papers 1119, Purdue University, Department of Economics.
  10. Charles Noussair & Stephane Robin & Bernard Ruffieux, 2001. "Price Bubbles in Laboratory Asset Markets with Constant Fundamental Values," Experimental Economics, Springer, vol. 4(1), pages 87-105, June.
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Cited by:
  1. Joep Sonnemans & Peter Heemeijer & Cars Hommes, 2005. "Price expectations in the laboratory in positive and negative feedback systems," Computing in Economics and Finance 2005 165, Society for Computational Economics.
  2. Heemeijer, P. & Hommes, C.H. & Sonnemans, J. & Tuinstra, J., 2004. "Forming price expectations in positive and negative feedback systems," CeNDEF Working Papers 04-15, Universiteit van Amsterdam, Center for Nonlinear Dynamics in Economics and Finance.
  3. Giulio Bottazzi & Giovanna Devetag & Francesca Pancotto, 2008. "Does Volatility matter? Expectations of price return and variability in an asset pricing experiment," CEEL Working Papers 0801, Cognitive and Experimental Economics Laboratory, Department of Economics, University of Trento, Italia.
  4. Giulio Bottazzi & Maria Giovanna Devetag, 2003. "Expectations Structure in Asset Pricing Experiments," LEM Papers Series 2003/19, Laboratory of Economics and Management (LEM), Sant'Anna School of Advanced Studies, Pisa, Italy.
  5. Sonnemans, Joep & Tuinstra, Jan, 2010. "Positive expectations feedback experiments and number guessing games as models of financial markets," Journal of Economic Psychology, Elsevier, vol. 31(6), pages 964-984, December.
  6. Pfajfar, D. & Zakelj, B., 2012. "Uncertainty and Disagreement in Forecasting Inflation: Evidence from the Laboratory (Revised version of CentER DP 2011-053)," Discussion Paper 2012-072, Tilburg University, Center for Economic Research.

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