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Experiments on Financial Markets

Paper Session

Saturday, Jan. 5, 2019 8:00 AM - 10:00 AM

Hilton Atlanta, 301
Hosted By: Society for Computational Economics
  • Chair: Te Bao, Nanyang Technological University

Adoption of a New Payment Method: Theory and Experimental Evidence

Jasmina Arifovic
,
Simon Fraser University

Abstract

We model the introduction of a new payment method, e.g., e-money, that competes with an existing payment method, e.g., cash. The new payment method involves relatively lower per-transaction costs for both buyers and sellers, but sellers must pay a fixed fee to accept the new payment method. As a result of the network effects, our model admits two symmetric pure strategy Nash equilibria. In one equilibrium, the new payment method is not adopted and all transactions continue to be carried out using the existing payment method. In the other equilibrium, the new payment method is adopted and completely replaces the existing payment method. The equilibrium involving only the new payment method is socially optimal as it minimizes total transaction costs. Using this model, we study the question of equilibrium selection by conducting a laboratory experiment. We find that, depending on the fixed fee charged for the adoption of the new payment method and on the choices made by participants on both sides of the market, either equilibrium can be selected. More precisely, a lower fixed fee for sellers favors very quick adoption of the new payment method by all participants, while for a sufficiently high fee, sellers gradually learn to refuse to accept the new payment method and transactions are largely conducted using the existing payment method. We also find that an evolutionary learning model captures the dynamics of the experimental data well.

Experimental Asset Markets with An Indenfiite Horizon

John Duffy
,
University of California-Irvine

Abstract

Abstract: We study the pricing and trade of infinitely lived assets in experimental markets. Our experimental design disentangles several confounding factors in such markets: (1) payoff uncertainty about the asset's dividend payments; (2) horizon uncertainty about the duration of trade in the asset, and (3) the assumption that agents are risk neutral expected utility maximizers. In a baseline treatment with all of these features or assumptions in place, we find that trading prices are on average more than 40% below the risk-neutral fundamental value, and decrease further as traders gain experience. In the two other treatments, we separate trade in the asset from dividend realizations. While there continues to exist uncertainty in the number of dividend payments, coupled with or without the uncertainty in the length of the trading horizon, we find that market prices in the latter two treatments are not significantly different from the asset's risk-neutral fundamental value. We therefore conclude that the low trading prices observed in our baseline, indefinite-horizon market cannot be explained by assuming risk neutral expected utility maximizers. By contrast, an Epstein-Zin recursive preference specification that allows risk preferences to be disentangled from preferences for certainty an account for the low trading prices observed in our baseline treatment. Indeed, a further contribution of our paper is that we propose a method to calculate the risk-adjusted market fundamental value of the asset under expected utility or under Epstein-Zin preferences, respectively.

Rational Expectations in an Experimental Asset Market with Shocks to Market Trends

Charles Noussair
,
University of Arizona

Abstract

We construct an experimental asset market in which the time trend of the fundamental value is subject to a shock. The design of the experiment allows testing of whether prices adhere to rational expectations levels, and whether there is over- or under-reaction to new information. We find that prices conform closely to rational expectations and episodes of mispricing are rare. A meta-analysis allows us to update our beliefs about whether experimental asset markets exhibit a generic tendency to misprice, particularly in bearish environments.

CEO Incentives and Stock Price Dynamics: An Experimental Approach

Te Bao
,
Nanyang Technological University

Abstract

We investigate experimentally how granting a CEO with stock ownership and the opportunity to trade influence the CEO’s effort and overall market behavior. In our design, CEO effort affects the fundamental value of the firm. Our findings suggest that stock ownership alone does not significantly increase the CEO’s effort. However, CEOs tend to accumulate additional shares when they are given the opportunity to trade, and this leads to greater CEO effort. In all treatments, prices tend to reflect underlying fundamentals and bubbles are rare. When CEOs receive stock ownership, price deviates less from the fundamental values. When CEOs can trade shares, the asset exhibits somewhat greater mispricing.
Discussant(s)
Nobuyuki Hanaki
,
University of Nice Sophia Antipolis
Yohanes Eko Riyanto
,
Nanyang Technological University
Songfa Zhong
,
National University of Singapore
Luba Petersen
,
Simon Fraser University
JEL Classifications
  • C6 - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling
  • C9 - Design of Experiments