Can Markets Learn to Avoid Bubbles?
AbstractOne of the most striking results in experimental economics is the ease with which market bubbles form in a laboratory setting and the difficulty of preventing them. This article re-examines bubble experiments in light of the results of an earlier series of market experiments that examine how learning occurs in markets characterized by an asymmetry of information between buyers and sellers, such as found in Akerlof’s lemons model and Spence’s signaling model and extends the arguments put forth in the author’s book, Paving Wall Street: Experimental Economics and the Quest for the Perfect Market. Markets with asymmetric information are incomplete because they lack markets for specific levels of product quality. Such markets either lump all qualities together (lemons) or using external indications of quality to separate them (signaling). Similarly, the markets used in bubble experiments are incomplete in that they are lacking a complete set of forward or futures markets, depriving traders of the information supplied by the prices in those markets. Preliminary experimental results suggest that the addition of a single forward market can sometimes mitigate bubble formation and this article suggests more extensive research in this direction is warranted. Market bubbles outside of the laboratory usually are found in markets in with forward and futures markets that are either legally restricted or otherwise limited. Experimentation in markets with asymmetric information also indicates that the ability of subjects to learn how to send and receive signals can be enhanced by changing the way that market information is presented to them. We explore how this result might be used to help asset markets learn to avoid bubbles.
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Bibliographic InfoPaper provided by EconWPA in its series Experimental with number 0201001.
Length: 18 pages
Date of creation: 07 Jan 2002
Date of revision: 07 Jan 2002
Note: Type of Document - PDF/Acrobat; prepared on Windows 98SE; to print on PDF compatible; pages: 18 ; figures: None. Forthcoming in the Journal of Psychology and Financial Markets
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Market bubbles; learning and adaptation; behavioral finance; signaling; asymmetric information;
Find related papers by JEL classification:
- C90 - Mathematical and Quantitative Methods - - Design of Experiments - - - General
- C92 - Mathematical and Quantitative Methods - - Design of Experiments - - - Laboratory, Group Behavior
- D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
- D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
This paper has been announced in the following NEP Reports:
- NEP-ALL-2002-01-22 (All new papers)
- NEP-EVO-2002-01-22 (Evolutionary Economics)
- NEP-EXP-2002-01-22 (Experimental Economics)
- NEP-FMK-2002-01-22 (Financial Markets)
- NEP-MAC-2002-01-05 (Macroeconomics)
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