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The dynamics of trader motivations in asset bubbles

Author

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  • Gunduz Caginalp

    ()

  • Vladimira Ilieva

    ()

Abstract

Asset market experiments are analyzed by distinguishing, ex post facto, participants who trade on fundamentals versus those who trade on momentum (i.e., buying when the price is rising). The distinction is made when prices are above fundamental value, so that (in each period) those who have more offers than bids (net offerers) are classified as fundamentalists while those who have more bids than offers (net bidders) are defined to be momentum players. By analyzing the data of individual behavior we are able to address a number of key questions regarding bubbles. We find evidence that the cash supply of the momentum traders diminishes and the cash supply of the fundamental traders increases as the bubble forms. This suggests that the bubble is fueled by the cash of the momentum players and the reversal is caused by inadequate cash in their possession. These data are used in conjunction with a difference equation for price dynamics for two groups. The momentum traders exhibit a positive coefficient for price derivatives and a very small negative coefficient for trading based upon the deviation from fundamental value. Surprisingly, however, the fundamental traders, who exhibit a positive coefficient for trading on valuation, also exhibit a significantly positive coefficient for trend based buying. Thus, even those who are net offerers, classified as fundamentalists, are selling less and buying more of overvalued stock when there is a strong positive recent price change. There is also evidence that some fundamentalists change strategy to momentum trading as prices soar. An additional result is that the trend coefficient of the momentum traders vanishes with the implementation of an “open book” that allows traders to see all trades as they are entered.

Suggested Citation

  • Gunduz Caginalp & Vladimira Ilieva, 2006. "The dynamics of trader motivations in asset bubbles," Labsi Experimental Economics Laboratory University of Siena 008, University of Siena.
  • Handle: RePEc:usi:labsit:008
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    References listed on IDEAS

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    1. Westerhoff, Frank H., 2004. "Multiasset Market Dynamics," Macroeconomic Dynamics, Cambridge University Press, vol. 8(05), pages 596-616, November.
    2. Lei, Vivian & Noussair, Charles N & Plott, Charles R, 2001. "Nonspeculative Bubbles in Experimental Asset Markets: Lack of Common Knowledge of Rationality vs. Actual Irrationality," Econometrica, Econometric Society, vol. 69(4), pages 831-859, July.
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    More about this item

    Keywords

    Experimental economics; Asset markets; Behavioral finance; Momentum traders; Fundamental traders;

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • C90 - Mathematical and Quantitative Methods - - Design of Experiments - - - General

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