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Another law of small numbers: patterns of trading prices in experimental markets

Author

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  • Tristan Roger

    (DRM-Finance - DRM - Dauphine Recherches en Management - Université Paris Dauphine-PSL - PSL - Université Paris sciences et lettres - CNRS - Centre National de la Recherche Scientifique)

  • Wael Bousselmi

    (CREST - Centre de Recherche en Economie et Statistique [Bruz] - ENSAI - Ecole Nationale de la Statistique et de l'Analyse de l'Information [Bruz])

  • Patrick Roger

    (LARGE - Laboratoire de recherche en gestion et économie - UNISTRA - Université de Strasbourg - L'europe en mutation : histoire, droit, économie et identités culturelles - UNISTRA - Université de Strasbourg - CNRS - Centre National de la Recherche Scientifique)

  • Marc Willinger

    (CEE-M - Centre d'Economie de l'Environnement - Montpellier - FRE2010 - Montpellier SupAgro - Institut national d’études supérieures agronomiques de Montpellier - Institut Agro - Institut national d'enseignement supérieur pour l'agriculture, l'alimentation et l'environnement - INRA - Institut National de la Recherche Agronomique - CNRS - Centre National de la Recherche Scientifique - UM - Université de Montpellier)

Abstract

Conventional finance models indicate that the magnitude of stock prices should not influence portfolio choices or future returns. This view is contradicted, however, by empirical evidence. In this paper, we report the results of an experiment showing that trading prices, in experimental markets, are processed differently by participants, depending on their magnitude. Our experiment has two consecutive treatments. One where the fundamental value is a small number (the small price market) and a second one where the fundamental value is a large number (the large price market). Small price markets exhibit greater mispricing than large price markets. We obtain this result both between-participants and within-participants. Our findings show that price magnitude influences the way people perceive the distribution of future returns. This result is at odds with standard finance theory but is consistent with: (1) a number of observations in the empirical finance and accounting literature; and (2) evidence in neuropsychology on the use of different mental scales for small and large numbers.

Suggested Citation

  • Tristan Roger & Wael Bousselmi & Patrick Roger & Marc Willinger, 2018. "Another law of small numbers: patterns of trading prices in experimental markets," Working Papers hal-01954921, HAL.
  • Handle: RePEc:hal:wpaper:hal-01954921
    Note: View the original document on HAL open archive server: https://hal.archives-ouvertes.fr/hal-01954921
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    References listed on IDEAS

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    1. Tristan Roger & Wael Bousselmi & Patrick Roger & Marc Willinger, 2018. "The effect of price magnitude on analysts' forecasts: evidence from the lab," Working Papers hal-01954919, HAL.

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    Keywords

    number perception; mental scales; behavioral bias; experimental markets; stock price magnitude;
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