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Speculation and Price Indeterminacy in Financial Markets: An Experimental Study

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To explore how speculative trading influences prices in financial markets, we conduct a laboratory market experiment with speculating investors (who do not collect dividends and trade only for capital gains) and dividend- collecting investors. Moreover, we operate markets at two di"erent levels of money supply. We "nd that in phases with only speculating investors present (i) price deviations from fundamentals are larger; (ii) prices are more volatile; (iii) mispricing increases with the number of transfers until maturity; and (iv) speculative trading pushes prices upward (downward) when the supply of money is high (low). These results suggest that controlling the money supply can help to stabilize asset prices.

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  • Shinichi Hirota & Juergen Huber & Thomas Stock & Shyam Sunder, 2018. "Speculation and Price Indeterminacy in Financial Markets: An Experimental Study," Cowles Foundation Discussion Papers 2134R, Cowles Foundation for Research in Economics, Yale University, revised Apr 2020.
  • Handle: RePEc:cwl:cwldpp:2134r
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    Keywords

    Experimental finance; Speculation; Rational expectations; Price efficiency; Price bubbles; Overlapping generations; Backward and forward induction;
    All these keywords.

    JEL classification:

    • C91 - Mathematical and Quantitative Methods - - Design of Experiments - - - Laboratory, Individual Behavior
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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