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Stock market bubbles in the laboratory

Author

Listed:
  • David Porter
  • Vernon Smith

Abstract

Trading at prices above the fundamental value of an asset, i.e. a bubble, has been verified and replicated in laboratory asset markets for the past seven years. To date, only common group experience provides minimal conditions for common investor sentiment and trading at fundamental value. Rational expectations models do not predict the bubble and crash phenomena found in these experimental markets; such models yield only equilibrium predictions and do not articulate a dynamic process that converges to fundamental value with experience. The dynamic models proposed by Caginalp et al. do an excellent job of predicting price patterns after calibration with a previous experimental bubble, given the initial conditions for a new bubble and its controlled fundamental value. Several extensions of this basic laboratory asset market have recently been undertaken which allow for margin buying, short selling, futures contracting, limit price change rules and a host of other changes that could effect price formation in these assets markets. This paper reviews the results of 72 laboratory asset market experiments which include experimental treatments for dampening bubbles that are suggested by rational expectations theory or popular policy prescriptions.

Suggested Citation

  • David Porter & Vernon Smith, 1994. "Stock market bubbles in the laboratory," Applied Mathematical Finance, Taylor & Francis Journals, vol. 1(2), pages 111-128.
  • Handle: RePEc:taf:apmtfi:v:1:y:1994:i:2:p:111-128
    DOI: 10.1080/13504869400000008
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    References listed on IDEAS

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    1. Victor Zarnowitz, 1986. "The Record and Improvability of Economic Forecasting," NBER Working Papers 2099, National Bureau of Economic Research, Inc.
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    Citations

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    Cited by:

    1. Stephen Cheung & Stefan Palan, 2012. "Two heads are less bubbly than one: team decision-making in an experimental asset market," Experimental Economics, Springer;Economic Science Association, vol. 15(3), pages 373-397, September.
    2. Markus Noth & Martin Weber, 2003. "Information Aggregation with Random Ordering: Cascades and Overconfidence," Economic Journal, Royal Economic Society, vol. 113(484), pages 166-189, January.
    3. Brice Corgnet & Roberto Hernán González & Praveen Kujal & David Porter, 2013. "The Effect of Earned vs. House Money on Price Bubble Formation in Experimental Asset Markets," Working Papers 13-04, Chapman University, Economic Science Institute.
    4. Tokic, Damir, 2011. "Rational destabilizing speculation, positive feedback trading, and the oil bubble of 2008," Energy Policy, Elsevier, vol. 39(4), pages 2051-2061, April.
    5. Mizuta, Hideyuki & Steiglitz, Ken & Lirov, Erez, 2003. "Effects of price signal choices on market stability," Journal of Economic Behavior & Organization, Elsevier, vol. 52(2), pages 235-251, October.
    6. Gregory Waymire & Sudipta Basu, 2011. "Economic crisis and accounting evolution," Accounting and Business Research, Taylor & Francis Journals, vol. 41(3), pages 207-232, August.
    7. Gunduz Caginalp & Vladimira Ilieva, 2006. "The dynamics of trader motivations in asset bubbles," Labsi Experimental Economics Laboratory University of Siena 008, University of Siena.
    8. Brice Corgnet & Roberto Hernán-González & Praveen Kujal & David Porter, 2015. "The Effect of Earned Versus House Money on Price Bubble Formation in Experimental Asset Markets," Review of Finance, European Finance Association, vol. 19(4), pages 1455-1488.
    9. Caginalp, Gunduz & Porter, David & Smith, Vernon, 2000. "Momentum and overreaction in experimental asset markets," International Journal of Industrial Organization, Elsevier, vol. 18(1), pages 187-204, January.
    10. Milo Bianchi & Philippe Jehiel, 2008. "Bubbles and crashes with partially sophisticated investors," PSE Working Papers halshs-00586045, HAL.
    11. Volodymyr Lugovskyy & Daniela Puzzello & Steven Tucker, 2009. "An Experimental Study of Bubble Formation in Asset Markets Using the Tâtonnement Pricing Mechanism," Working Papers in Economics 09/19, University of Canterbury, Department of Economics and Finance.
    12. Fridrik Baldursson & Jon Sturluson, 2011. "Fees and the Efficiency of Tradable Permit Systems: An Experimental Approach," Environmental & Resource Economics, Springer;European Association of Environmental and Resource Economists, vol. 48(1), pages 25-41, January.
    13. Donald T. Wargo & Norman A. Baglini & Katherine A. Nelson, 2010. "The New Millennium’s First Global Financial Crisis: The Neuroeconomics of Greed, Self-interest, Deception, False Trust, Overconfidence and Risk Perception," Chapters,in: Neuroeconomics and the Firm, chapter 5 Edward Elgar Publishing.
    14. John Dickhaut & Shengle Lin & David Porter & Vernon L. Smith, 2010. "Durability, Re-trading and Market Performance," Working Papers 10-01, Chapman University, Economic Science Institute.
    15. Cary Deck & David Porter & Vernon L. Smith, 2011. "Double Bubbles in Assets Markets with Multiple Generations," Working Papers 11-10, Chapman University, Economic Science Institute.
    16. Hawkins, Raymond J., 2011. "Lending sociodynamics and economic instability," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 390(23), pages 4355-4369.
    17. Nuriddin Ikromov & Abdullah Yavas, 2012. "Cash Flow Volatility, Prices and Price Volatility: An Experimental Study," The Journal of Real Estate Finance and Economics, Springer, vol. 44(1), pages 203-229, January.
    18. Caginalp, G. & Ilieva, V., 2008. "The dynamics of trader motivations in asset bubbles," Journal of Economic Behavior & Organization, Elsevier, vol. 66(3-4), pages 641-656, June.
    19. Carmela Mauro, 2008. "Uncertainty Aversion Vs. Competence: An Experimental Market Study," Theory and Decision, Springer, vol. 64(2), pages 301-331, March.
    20. Ernst Fehr & Jean-Robert Tyran, 2005. "Individual Irrationality and Aggregate Outcomes," Journal of Economic Perspectives, American Economic Association, vol. 19(4), pages 43-66, Fall.
    21. G. Caginalp & H. Laurent, 1998. "The predictive power of price patterns," Applied Mathematical Finance, Taylor & Francis Journals, vol. 5(3-4), pages 181-205.
    22. Corgnet Bruce & Angela Sutan & Arvin Aashta, 2006. "The power of words in financial markets: soft versus hard communication,a strategy method experiment," Labsi Experimental Economics Laboratory University of Siena 006, University of Siena.
    23. Ehsan Ahmed & J. Barkley Rosser Jr. & Jamshed Y. Uppal, 2010. "Emerging Markets and Stock Market Bubbles: Nonlinear Speculation?," Emerging Markets Finance and Trade, Taylor & Francis Journals, vol. 46(4), pages 23-40, January.

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