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Price Stability and Volatility in Markets with Positive and Negative Expectations Feedback: An Experimental Investigation

  • Jan Tuinstra
  • Joep Sonnemans
  • Cars Hommes
  • Peter Heemeijer

The evolution of many economic variables is affected by expectations that economic agents have with respect to the future development of these variables. Here we show, by means of laboratory experiments, that market behavior depends to a large extent on how the realized market price responds to an increase in average price expectations. If it responds by decreasing, as in commodity markets, prices converge quickly to their equilibrium value, confirming the rational expectations hypothesis. If the realized price increases after an increase of average expectations, as is typical for financial markets, large fluctuations in realized prices are likely.

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File URL: http://www2.warwick.ac.uk/fac/soc/wbs/research/wfri/rsrchcentres/ferc/wrkingpaprseries/fwp06-18.pdf
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Paper provided by Warwick Business School, Finance Group in its series Working Papers with number wp06-18.

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Date of creation: 2006
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Handle: RePEc:wbs:wpaper:wp06-18
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