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Price Stability and Volatility in Markets with Positive and Negative Expectations Feedback: An Experimental Investigation

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  • Jan Tuinstra
  • Joep Sonnemans
  • Cars Hommes
  • Peter Heemeijer

Abstract

The evolution of many economic variables is affected by expectations that economic agents have with respect to the future development of these variables. We show, by means of laboratory experiments, that market behavior depends to a large extent on whether realized market prices respond positively or negatively to average price expectations. In the case of negative expectations feedback, as in commodity markets, prices converge quickly to their equilibrium value, confirming the rational expectations hypothesis. In the case of positive expectations feedback, as is typical for speculative asset markets, large fluctuations in realized prices and persistent deviations from the benchmark fundamental price are likely. We estimate individual forecasting rules and investigate how these explain the differences in aggregate market outcomes.

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Paper provided by Warwick Business School, Finance Group in its series Working Papers with number wp06-18.

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Date of creation: 2006
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Handle: RePEc:wbs:wpaper:wp06-18

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