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Can Markets Learn to Avoid Bubbles?

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  • Ross M. Miller

    (Miller Risk Advisors)

Abstract

One of the most striking results in experimental economics is the ease with which market bubbles form in a laboratory setting and the difficulty of preventing them. This article re-examines bubble experiments in light of the results of an earlier series of market experiments that examine how learning occurs in markets characterized by an asymmetry of information between buyers and sellers, such as found in Akerlof’s lemons model and Spence’s signaling model and extends the arguments put forth in the author’s book, Paving Wall Street: Experimental Economics and the Quest for the Perfect Market. Markets with asymmetric information are incomplete because they lack markets for specific levels of product quality. Such markets either lump all qualities together (lemons) or using external indications of quality to separate them (signaling). Similarly, the markets used in bubble experiments are incomplete in that they are lacking a complete set of forward or futures markets, depriving traders of the information supplied by the prices in those markets. Preliminary experimental results suggest that the addition of a single forward market can sometimes mitigate bubble formation and this article suggests more extensive research in this direction is warranted. Market bubbles outside of the laboratory usually are found in markets in with forward and futures markets that are either legally restricted or otherwise limited. Experimentation in markets with asymmetric information also indicates that the ability of subjects to learn how to send and receive signals can be enhanced by changing the way that market information is presented to them. We explore how this result might be used to help asset markets learn to avoid bubbles.

Suggested Citation

  • Ross M. Miller, 2002. "Can Markets Learn to Avoid Bubbles?," Experimental 0201001, EconWPA, revised 07 Jan 2002.
  • Handle: RePEc:wpa:wuwpex:0201001
    Note: Type of Document - PDF/Acrobat; prepared on Windows 98SE; to print on PDF compatible; pages: 18 ; figures: None. Forthcoming in the Journal of Psychology and Financial Markets
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    File URL: https://econwpa.ub.uni-muenchen.de/econ-wp/exp/papers/0201/0201001.pdf
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    References listed on IDEAS

    as
    1. Ross M. Miller & Charles R. Plott & Vernon L. Smith, 1977. "Intertemporal Competitive Equilibrium: An Empirical Study of Speculation," The Quarterly Journal of Economics, Oxford University Press, vol. 91(4), pages 599-624.
    2. Caginalp, Gunduz & Porter, David & Smith, Vernon, 2000. "Momentum and overreaction in experimental asset markets," International Journal of Industrial Organization, Elsevier, vol. 18(1), pages 187-204, January.
    3. Lynch, Michael & Miller, Ross M. & Plott, Charles R. & Porter, Russell., 1984. "Product Quality, Informational Efficiency and Regulations in Experimental Markets," Working Papers 518, California Institute of Technology, Division of the Humanities and Social Sciences.
    4. Vernon L. Smith, 1962. "An Experimental Study of Competitive Market Behavior," Journal of Political Economy, University of Chicago Press, vol. 70, pages 322-322.
    5. Shleifer, Andrei & Vishny, Robert W, 1997. " The Limits of Arbitrage," Journal of Finance, American Finance Association, vol. 52(1), pages 35-55, March.
    6. Garber, Peter M, 1990. "Famous First Bubbles," Journal of Economic Perspectives, American Economic Association, vol. 4(2), pages 35-54, Spring.
    7. Michael Rothschild & Joseph Stiglitz, 1976. "Equilibrium in Competitive Insurance Markets: An Essay on the Economics of Imperfect Information," The Quarterly Journal of Economics, Oxford University Press, vol. 90(4), pages 629-649.
    8. Miller, Ross M & Plott, Charles R, 1985. "Product Quality Signaling in Experimental Markets," Econometrica, Econometric Society, vol. 53(4), pages 837-872, July.
    9. Lucas, Robert Jr., 1972. "Expectations and the neutrality of money," Journal of Economic Theory, Elsevier, vol. 4(2), pages 103-124, April.
    10. Wilson, Charles, 1977. "A model of insurance markets with incomplete information," Journal of Economic Theory, Elsevier, vol. 16(2), pages 167-207, December.
    11. Porter, David P & Smith, Vernon L, 1995. "Futures Contracting and Dividend Uncertainty in Experimental Asset Markets," The Journal of Business, University of Chicago Press, vol. 68(4), pages 509-541, October.
    12. Forsythe, Robert & Palfrey, Thomas R & Plott, Charles R, 1982. "Asset Valuation in an Experimental Market," Econometrica, Econometric Society, vol. 50(3), pages 537-567, May.
    13. George A. Akerlof, 1970. "The Market for "Lemons": Quality Uncertainty and the Market Mechanism," The Quarterly Journal of Economics, Oxford University Press, vol. 84(3), pages 488-500.
    14. Tversky, Amos & Kahneman, Daniel, 1986. "Rational Choice and the Framing of Decisions," The Journal of Business, University of Chicago Press, vol. 59(4), pages 251-278, October.
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    Cited by:

    1. Miller, Ross M., 2008. "Don't let your robots grow up to be traders: Artificial intelligence, human intelligence, and asset-market bubbles," Journal of Economic Behavior & Organization, Elsevier, vol. 68(1), pages 153-166, October.
    2. Kocher, Martin G. & Lucks, Konstantin E. & Schindler, David, 2016. "Unleashing Animal Spirits - Self-Control and Overpricing in Experimental Asset Markets," Discussion Papers in Economics 27572, University of Munich, Department of Economics.
    3. Robert C. Merton & Zvi Bodie, 2004. "The Design of Financial Systems: Towards a Synthesis of Function and Structure," NBER Working Papers 10620, National Bureau of Economic Research, Inc.
    4. Stefanescu, Razvan & Dumitriu, Ramona, 2016. "Particularitǎţi ale evoluţiei variabilelor financiare
      [Some particularities of the financial variables evolution]
      ," MPRA Paper 73481, University Library of Munich, Germany, revised 02 Sep 2016.

    More about this item

    Keywords

    Market bubbles; learning and adaptation; behavioral finance; signaling; asymmetric information;

    JEL classification:

    • C90 - Mathematical and Quantitative Methods - - Design of Experiments - - - General
    • C92 - Mathematical and Quantitative Methods - - Design of Experiments - - - Laboratory, Group Behavior
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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