The Neural Inhibition of Learning Increases Asset Market Bubbles: Experimental Evidence

The authors tested a leading theory of bubble formation, insufficient learning, in a laboratory asset market using a drug, Naltrexone, which inhibits reinforcement learning. We found that asset price bubbles in Naltrexone sessions were larger compared with placebo sessions, averaging 60% higher in amplitude and 77% larger in the deviation from fundamental value in the final 12-period trading round. There was no difference between conditions in understanding of the trading rules, overconfidence, or confusion. Participants on Naltrexone appeared unable to determine appropriate trading strategies as prices changed. The findings indicate that specific neural mechanism of reinforcement learning is involved in the formation of asset market bubbles.     

Dividend timing and behavior in laboratory asset markets

Summary. This paper investigates the effect of dividend timing on price bubbles and endogenous expectations in twenty-six laboratory asset markets. In ten "A1" markets, a single dividend is paid at the end of the trading horizon. In nine "A2" markets, dividends are paid at the end of each trading period. In seven "A3" markets, some of the dividends are paid at the end of the trading horizon, and the rest are paid on a per-period basis. The results indicate that price bubbles are most likely in A2 markets, less likely in A3 markets, and least likely in A1 markets. Six distinct hypotheses are considered. The data suggest that the concentration of dividend value at a single point in time helps to create common expectations, and thus significantly reduce the incidence of bubbles. Also, the results underscore the difficulty facing econometric tests on field data where fundamental value has to be approximated.     

PRODUCE OR SPECULATE? ASSET BUBBLES,OCCUPATIONAL CHOICE,AND EFFICIENCY*

We study the effects of rational asset bubbles in an overlapping‐generations economy where asset trading requires specialized intermediaries and agents freely choose between working in the production or the financial sector. Frictions in the market for deposits create rents in the financial sector that affect agents’ occupational choices. When rents are large, the private gains associated with trading bubbles lead too many agents to become speculators, causing bubbles to lose their efficiency properties. Moreover, if speculation can be carried out by skilled labor only, then bubbles displace skilled workers away from the productive sector and raise income inequalities.     

Price Bubbles in Laboratory Asset Markets with Constant Fundamental Values

We construct asset markets that are similar to those studied by Smith, Suchanek and Williams (Econometrica. 56, 1119–1151) in which bubbles and crashes tended to occur. The main difference between the markets studied here and those studied by Smith et al. is that in the markets studied here, the fundamental value of the asset is constant over the entire life of the asset. In four of the eight sessions reported here, we observe bubbles, which are prices considerably higher than fundamental values. The data suggest that the frequent payment of dividends is a major cause of bubble formation. The property that the fundamental value remains constant over the course of the trading horizon is not sufficient to eliminate the possibility of a bubble.     

Two-period trading sentiment asset pricing model with information

We present a dynamic asset pricing model with investor sentiment and information, which shows that the investor sentiment plays a systematic and important role in the asset prices and the information is gradually incorporated into prices. The model has an analytical solution to the sentiment equilibrium price. We find that sentiment trading quantity not only increases the market liquidity, but also causes the asset prices' overreaction if the intensity of sentiment demand is more than a constant value. Therefore, the continuing overreactions result in a short-term momentum and a long-term reversal. The model could offer a partial explanation to some financial anomalies such as price bubbles, high volatility, asset prices' overreaction and so on.     

Uniqueness of asset prices in an exchange economy with unbounded utility

Summary. This paper studies conditions under which the price of an asset is uniquely determined by its fundamental value – i.e., no bubbles can arise – in Lucas-type asset pricing models with unbounded utility. After discussing Gilles and LeRoy's (1992) example, we construct an example of a two-period, representative agent economy to demonstrate that bubbles can arise in a standard model if utility is unbounded below, in which case the stochastic Euler equation may be violated. In an infinite horizon framework, we show that bubbles cannot arise if the optimal sequence of asset holdings can be lowered uniformly without incurring an infinite utility loss. Using this result, we develop conditions for the nonexistence of bubbles. The conditions depend exclusively on the asymptotic behavior of marginal utility at zero and infinity. They are satisfied by many unbounded utility functions, including the entire CRRA (constant relative risk aversion) class. The Appendix provides a complete market version of our two-period example. Received: January 22, 1996; revised version: February 18, 1997     

Determinants of stock price bubbles

In this paper we propose a cross-sectional model of the determinants of asset price bubbles. Using 589 firms listed on the NYSE, we find conclusive evidence that trading volume and share price volatility have statistically significant effects on asset price bubbles. However, evidence from sector-based stocks is mixed. We find that for firms belonging to electricity, energy, financial, and banking sectors, and for the smallest size firms, trading volume has a statistically significant and positive effect on bubbles. We do not discover any robust evidence of a statistically significant effect of share price volatility on bubbles at the sector-level.     

Overconfidence and Bubbles in Experimental Asset Markets

This paper investigates the relationship between market overconfidence and occurrence of stock-price bubbles. Sixty participants traded stocks in 10 experimental asset markets. Markets were constructed on the basis of subjects' overconfidence: The most overconfident subjects form high overconfidence markets and the least overconfident subjects low overconfidence markets. Prices in low overconfidence markets tend to track the fundamental asset value more accurately than prices in high overconfidence markets and are significantly lower and less volatile. Additionally, we observe significantly higher bubble measures and trading volume in high overconfidence markets. Two possible explanations for these differences are analyzed: While price expectations are significantly higher in high overconfidence markets, no differences in the average degree of risk aversion were detected.     

INEFFICIENT INFORMATION AGGREGATION AS A SOURCE OF ASSET PRICE BUBBLES

This paper presents a new theory of bubbles, or discrepancies between the market clearing price and the fundamental value of an asset. In our setting, Bayesian traders, oriented towards long-term gains, receive private information ('news') and also make inferences from noisy price signals. Price exhibits higher variance than fundamental value (the latter defined as fully-aggregated expected value) especially when news is informative but infrequent. The corresponding bubbles are self-limiting but may exhibit momentum and overshooting. A parametric example, involving the exponential/gamma conjugate families, is provided.
We don't have any penetrating explanations of yesterday's stock market, but we certainly believe that stocks do not fall 86½ points for nothing.
The general case for a drop in the market after its recent record highs is clear enough. The Fed…,… the tax bill.
None of this, though, was any different on Thursday than it was with the market at its peak six sessions ago. News…and rumors yesterday…were certainly negative but scarcely dramatic.
Some market pros believe this kind of a drop is merely the market catching up with what it already knew. We doubt it. Our hunch is that something changed between Wednesday and Thursday, and that eventually we'll learn what it was ( Wall Street Journal Editorial, Friday, September 12, 1986).     

Financial leverage and market volatility with diverse beliefs

We study a general equilibrium model of asset trading with financial leverage, where the investors can engage in speculative trading with diverse beliefs about the asset??s fundamental value. We show that an increase in the leverage ratio causes the stock price to rise in the current period through a ??leverage effect??, and will result in more borrowing and more stock purchase that pumps the stock price higher in the subsequent period, known as the ??pyramiding effect??. There can also be a ??depyramiding effect?? when the price falls because lenders issue margin calls and force stock sales, contributing to further stock price plummeting. Price changes from depyramiding effect, however, may not take effect when margin calls are not triggered. We demonstrate that, under certain conditions, decreasing leverage ratios leads to lower stock price volatility, measured by the variation of prices caused by an exogenous shock, when the shock is unanticipated. The influences of dispersion of beliefs and available investment funds on the relation between financial leverage and market volatility are also examined. When the shock is anticipated, we demonstrate that reducing leverage ratios may not lower stock price volatility, which poses an important challenge to future studies on this issue.     

Price manipulation in an experimental asset market

We analyze in the laboratory whether an uninformed trader is able to manipulate the price of a financial asset by comparing the results of two experimental treatments. In the benchmark treatment, 12 subjects trade a common value asset that takes either a high or a low value. Only three subjects know the actual value of the asset while the market is open for trading. The manipulation treatment is identical to the benchmark treatment apart from the fact that we introduce a computer program as an additional uninformed trader. This robot buys a fixed number of shares in the beginning of a trading period and sells them again afterwards. Our main result shows that the last contract price is significantly higher in the manipulation treatment if the asset takes a low value and that private information is very well disseminated by both markets if the value of the asset is high. Finally, even though this simple manipulation program loses money on average, it is profitable in some instances.     

Asset price bubbles and crashes with near-zero-intelligence traders

Summary. We examine whether a simple agent-based model can generate asset price bubbles and crashes of the type observed in a series of laboratory asset market experiments beginning with the work of Smith, Suchanek and Williams (1988). We follow the methodology of Gode and Sunder (1993, 1997) and examine the outcomes that obtain when populations of zero-intelligence (ZI) budget constrained, artificial agents are placed in the various laboratory market environments that have given rise to price bubbles. We have to put more structure on the behavior of the ZI-agents in order to address features of the laboratory asset bubble environment. We show that our model of near-zero-intelligence traders, operating in the same double auction environments used in several different laboratory studies, generates asset price bubbles and crashes comparable to those observed in laboratory experiments and can also match other, more subtle features of the experimental data.Received: 15 July 2003, Revised: 28 September 2004, JEL Classification Numbers: D83, D84, G12. Correspondence to: John DuffyWe would like to thank an Anonymous referee, Guillaume Frechette, David Laibson, Al Roth and participants in Harvard Experimental and Behavioral Economics Workshop for their comments, and Charles Noussair for providing his data set.     

FUTURES MARKETS AND BUBBLE FORMATION IN EXPERIMENTAL ASSET MARKETS*

Abstract. We construct asset markets of the type studied in Smith et al. (1988) , in which price bubbles and crashes are widely observed. In addition to a spot market, there are futures markets in operation, one maturing at the beginning of each period of the life of the asset. We find that when futures markets are present, bubbles do not occur in the spot markets. The futures markets seem to reduce the speculation and the decision errors that appear to give rise to price bubbles in experimental asset markets.     

Bubble measures in experimental asset markets

We review bubble measures which are commonly used in the experimental asset market literature. It seems sensible to require that measures of mispricing should (i) relate the fundamental value and price, (ii) be monotone in the difference between fundamental value and price, and (iii) be independent of the total number of periods and the absolute level of fundamental value. We show that none of the measures currently used fulfills all these criteria. To facilitate comparability across different experimental settings with different parameterizations we propose two alternative measures which fulfill all evaluation criteria. The measure for mispricing, RAD (relative absolute deviation), is calculated by averaging absolute differences between the (volume-weighted) mean price and the fundamental value across all periods and normalizing it with the absolute value of the average FV of the market. The measure for overvaluation, RD (relative deviation), is calculated analogously, but uses raw difference between (volume-weighted) mean prices and fundamental values. Hence, it provides information on whether the mispricing stems from over- or undervaluation of the asset.     

论投机性泡沫的内生性——基于一个模拟投机交易过程的经验模型

通过一个简约的模拟投机交易的经验模型,阐述了投机性泡沫是投机者对资产价格预期的一种自我实现①,它内生于投机者对资产价格进行无约束的套利交易过程中,其内在机制是交易数量的加速膨胀和预期的资产价格增长的相互作用。并据此认为政府管理部门首先应根据经济宏观和微观运行状况,结合资产的特点,为资产价格确立一个目标区域,并运用结构性的货币政策、延展交易资产的持有时间以及征收交易税等手段对资产价格进行有效管理,以防范投机性泡沫的形成和扩展。     

Asset bubbles,labour market frictions and R&D‐based growth

Employing an overlapping generations model of R&D‐based growth with labour market frictions, this paper examines how employment changes induced by labour market frictions influence asset bubbles and long‐run economic growth. Asset bubbles can (cannot) exist when the employment rate is high (low), which leads to higher (lower) economic growth through labour market efficiency. We also explore the steady state and transitional dynamics of bubbles, economic growth and employment. Furthermore, we show that policy or parameter changes with a negative influence on the labour market can lead to a bubble burst.     

Efficient ‘myopic’ asset pricing in general equilibrium: A potential pitfall in excess volatility tests

Excess volatility tests for financial market efficiency maintain the hypothesis of risk neutrality. This permits the specification of the benchmark efficient market price as the present discounted value of expected future dividends. By departing from the risk neutrality assumption in a stripped-down version of Lucas's general equilibrium asset pricing model, I show that asset prices determined in a competitive asset market and efficient by construction can nevertheless violate the variance bounds established under the assumption of risk neutrality. This can occur even without the problems of non-stationarity (including bubbles) and finite samples. Standard excess volatility tests are joint tests of market efficiency and risk neutrality. Failure of an asset price to pass the test may be due to the absence of risk neutrality rather than to market inefficiency.     

Do Speculative Stocks Lower Prices and Increase Volatility of Value Stocks?

The influence of speculative stocks on value stocks is examined through a set of economics experiments. The speculative asset is designed to model a company involved in a rapidly growing market that will be saturated at some unknown point. Using a control experiment where both assets are similar value stocks, we find statistical support for the assertion that the presence of a speculative stock increases the volatility and diminishes the price of the value stock. In addition, the temporal minimum price of the value stock during the last phase of the experiment is lower in the presence of the speculative stock (when the trading price of the speculative asset is declining sharply). These results indicate that an overreaction in the speculative stock tends to divert investment capital away from other assets. An examination of the relative magnitude of monthly closing price changes confirm strong correlations between the Dow Jones Average and the more speculative Nasdaq index during the time period 1990 to 2001 and particularly during the two years prior to the peak in March 2000 (0.72 correlation) and the March 2000 to August 2001 decline (0.79 correlation). Supplementary experiments using independent (or legally separate) markets trading the same asset show that a higher price in one market does not lead to a higher one in the other.     

Manipulating market sentiment

We analyze a simple model of an asset market, in which a large rational trader interacts with “noise speculators” who seek short-run speculative gains, and become active following a prolonged episode of mispricing relative to the asset’s fundamental value. The model gives rise to price patterns such as bubble dynamics, positive short-run correlation and vanishing long-run correlation of price deviations from the fundamental value. We argue that this example model sheds light on the question as to whether rational speculators abet or curb price fluctuations.