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Eliminating Laboratory Asset Bubbles by Paying Interest on Cash

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  • Giusti, Giovanni
  • Jiang, Janet Hua
  • Xu, Yiping

Abstract

The seminal work of Smith Suchanek and Williams (1988) finds price bubbles are frequently observed in an experimental asset market where a single asset with a finite lifetime is traded. Ever since, many studies have been carried out to understand the reason why bubbles occur in such an environment and to find mechanisms to eliminate bubbles.In this paper, we introduce an interest-bearing savings account to the experimental asset market. We find bubbles disappear with high interest rates. The effect of the interest rate potentially works in two ways. First, the savings account increases the opportunity cost of buying shares, which in turn, reduces the incentive to speculate and alleviates the “active participation” problem as raised in Lei, Noussair and Plott (2001). Second, fixing the dividend process and terminal value of the asset, the time trend of the fundamental value of the asset becomes positive with a high interest rate. An increasing fundamental value is more compatible with subjects’ perception that asset prices tend to be flat or increasing in the long run. Therefore, subjects are more likely to follow the fundamental value when they trade and over-pricing is lessened. To disentangle the effects through the two channels, we run a second set of experiments with high interest rate but a lower terminal value to induce the fundamental value of the asset to decrease over time. Bubbles reappear in these sessions, which suggests the time path of the fundamental value is more important for reducing bubbles.

Suggested Citation

  • Giusti, Giovanni & Jiang, Janet Hua & Xu, Yiping, 2012. "Eliminating Laboratory Asset Bubbles by Paying Interest on Cash," MPRA Paper 37321, University Library of Munich, Germany.
  • Handle: RePEc:pra:mprapa:37321
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    References listed on IDEAS

    as
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    3. Noussair, C. & Robin, S. & Ruffieux, B., 1998. "Bubbles and Anti-Crashes in Laboratory Asset Markets with Constant Fundamental Values," Purdue University Economics Working Papers 1119, Purdue University, Department of Economics.
    4. Volodymyr Lugovskyy & Daniela Puzzello & Steven Tucker, 2011. "An Experimental Study of Bubble Formation in Asset Markets Using the Tâtonnement Trading Institution," Working Papers in Economics 11/07, University of Canterbury, Department of Economics and Finance.
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    Citations

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    Cited by:

    1. Lugovskyy, Volodymyr & Puzzello, Daniela & Tucker, Steven & Williams, Arlington, 2014. "Asset-holdings caps and bubbles in experimental asset markets," Journal of Economic Behavior & Organization, Elsevier, vol. 107(PB), pages 781-797.
    2. repec:eee:beexfi:v:13:y:2017:i:c:p:42-50 is not listed on IDEAS
    3. da Gama Batista, João & Massaro, Domenico & Bouchaud, Jean-Philippe & Challet, Damien & Hommes, Cars, 2017. "Do investors trade too much? A laboratory experiment," Journal of Economic Behavior & Organization, Elsevier, vol. 140(C), pages 18-34.
    4. Breaban, A.G. & Noussair, C.N., 2014. "Fundamental Value Trajectories and Trader Characteristics in an Asset Market Experiment," Discussion Paper 2014-010, Tilburg University, Center for Economic Research.
    5. Nuzzo, Simone & Morone, Andrea, 2017. "Asset markets in the lab: A literature review," Journal of Behavioral and Experimental Finance, Elsevier, vol. 13(C), pages 42-50.
    6. Breaban, A. & Noussair, C.N., 2013. "Emotional state and Market Behavior," Discussion Paper 2013-031, Tilburg University, Center for Economic Research.
    7. Fischbacher, Urs & Hens, Thorsten & Zeisberger, Stefan, 2013. "The impact of monetary policy on stock market bubbles and trading behavior: Evidence from the lab," Journal of Economic Dynamics and Control, Elsevier, vol. 37(10), pages 2104-2122.
    8. Charles N. Noussair & Steven Tucker, 2016. "Cash Inflows And Bubbles In Asset Markets With Constant Fundamental Values," Economic Inquiry, Western Economic Association International, vol. 54(3), pages 1596-1606, July.
    9. Thomas Stöckl & Jürgen Huber & Michael Kirchler, 2015. "Multi-period experimental asset markets with distinct fundamental value regimes," Experimental Economics, Springer;Economic Science Association, vol. 18(2), pages 314-334, June.
    10. Breaban, A.G., 2014. "Behavior and asset markets : Individual decisions, emotions and fundamental value trajectories," Other publications TiSEM a20e6a40-f15e-4331-83cb-c, Tilburg University, School of Economics and Management.
    11. Stefan Palan, 2013. "A Review of Research into Smith, Suchanek and Williams Markets," Working Paper Series, Social and Economic Sciences 2013-04, Faculty of Social and Economic Sciences, Karl-Franzens-University Graz.

    More about this item

    Keywords

    Asset Bubbles; Experimental Economics;

    JEL classification:

    • C90 - Mathematical and Quantitative Methods - - Design of Experiments - - - General
    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)

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