Eliminating Laboratory Asset Bubbles by Paying Interest on Cash

Giovanni Giusti, Janet Hua Jiang and Yiping Xu

MPRA Paper from University Library of Munich, Germany

Abstract: The seminal work of Smith Suchanek and Williams (1988) finds price bubbles are frequently observed in an experimental asset market where a single asset with a finite lifetime is traded. Ever since, many studies have been carried out to understand the reason why bubbles occur in such an environment and to find mechanisms to eliminate bubbles.In this paper, we introduce an interest-bearing savings account to the experimental asset market. We find bubbles disappear with high interest rates. The effect of the interest rate potentially works in two ways. First, the savings account increases the opportunity cost of buying shares, which in turn, reduces the incentive to speculate and alleviates the “active participation” problem as raised in Lei, Noussair and Plott (2001). Second, fixing the dividend process and terminal value of the asset, the time trend of the fundamental value of the asset becomes positive with a high interest rate. An increasing fundamental value is more compatible with subjects’ perception that asset prices tend to be flat or increasing in the long run. Therefore, subjects are more likely to follow the fundamental value when they trade and over-pricing is lessened. To disentangle the effects through the two channels, we run a second set of experiments with high interest rate but a lower terminal value to induce the fundamental value of the asset to decrease over time. Bubbles reappear in these sessions, which suggests the time path of the fundamental value is more important for reducing bubbles.

Keywords: Asset Bubbles; Experimental Economics (search for similar items in EconPapers)
JEL-codes: C90 G10 (search for similar items in EconPapers)
Date: 2012-03-12
New Economics Papers: this item is included in nep-exp
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (19)

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https://mpra.ub.uni-muenchen.de/54970/1/MPRA_paper_54970.pdf revised version (application/pdf)

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