Mental capabilities, trading styles, and asset market bubbles: theory and experiment

Andreas Hefti, Steve Heinke () and Frédéric Schneider

No 234, ECON - Working Papers from Department of Economics - University of Zurich

Abstract: We propose that heterogeneous asset trading behavior is the result of two distinct, non-convertible mental dimensions: analytical (“quantitative”) capability and mentalizing (“perspective-taking”) capability. We develop a framework of mental capabilities that yields testable predictions about individual trading behavior, revenue distribution and aggregate outcomes. The two-dimensional structure of mental capabilities predicts the existence of four mental types with distinguishable trading patterns and revenues. Individuals will trade most successfully if and only if they have both capabilities. On the other hand, subjects who can mentalize well but have poor analytical capability will suffer the largest losses. As a consequence, being able in just one dimension does not assure trading success. We test these implications in a laboratory environment, where we first independently elicit subjects’ capabilities in both dimensions and then conduct a standard asset market experiment. We find that individual trading gains and patterns are consistent with our theoretical predictions. Our results suggest that two mental dimensions are necessary to encompass the complex heterogeneous behaviors in asset markets; a one-dimensional measure of mental capability will lead to biased conclusions. The findings have potential implications for financial institutions, which can use the measures to select successful traders, or for policy-makers, helping them to prevent the formation of asset bubbles. Finally, our conceptual framework and the empirical screening method could be applied to explain heterogeneous behavior in other games.

Keywords: Asset markets; heterogeneity; mental capabilities (search for similar items in EconPapers)
JEL-codes: C92 G02 (search for similar items in EconPapers)
Date: 2016-08
New Economics Papers: this item is included in nep-cbe, nep-exp and nep-neu
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (27)

Downloads: (external link)
https://www.zora.uzh.ch/id/eprint/125847/1/econwp234.pdf (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:zur:econwp:234

Access Statistics for this paper

More papers in ECON - Working Papers from Department of Economics - University of Zurich Contact information at EDIRC.
Bibliographic data for series maintained by Severin Oswald ().