Basic Principles of Asset Pricing Theory: Evidence From Large-Scale Experimental Financial Markets

Peter Bossaerts () and Charles Plott ()

No 1070, Working Papers from California Institute of Technology, Division of the Humanities and Social Sciences

Abstract: We report on six large-scale nancial markets experiments that were designed to test two of the most basic propositions of modern asset pricing theory, namely, that the interaction between risk averse agents in a competitive market leads to equilibration, and that, in equilibrium, risk premia are solely determined by covariance with aggregate risk. We designed the experiments within the framework suggested by two theoretical models, namely, Arrow and Debreu's complete-markets model, and the Sharpe-Lintner-Mossin Capital Asset Pricing Model (CAPM). This framework enabled us to measure how far our markets were from equilibrium at any point in time, thereby allowing us to gauge the success of the models. The distance measures do not require knowledge of the (uncontrollable) level and dispersion of risk aversion among subjects, and adjust for the impact of progressive trading on the eventual equilibrium. Unlike in our earlier, thin-markets experiments, we discovered swift convergence towards equilibrium prices of Arrow and Debreu's model or the CAPM. This discovery is significant, because subjects always lacked the information to deliberately set asset prices using either model. Sometimes, however, the equilibrium was not found to be robust, with markets readily veering away, apparently as a result of deviations of subjective beliefs from objective probabilities. Still, we find evidence that this did not destroy the tendency for markets to equilibrate as predicted by the theory. In each experiment, we formally test and reject the hypothesis that prices are a random walk, in favor of stochastic convergence towards CAPM and Arrow Debreu equilibrium.

Keywords: General Equilibrium Theory; Capital Asset Pricing Model; Complete Markets; Experimental Economics; Efficient Markets Hypothesis; Price Discovery (search for similar items in EconPapers)
Pages: 48 pages
Date: 2000-01
New Economics Papers: this item is included in nep-exp, nep-fin and nep-fmk
References: Add references at CitEc
Citations:

Published:

Downloads: (external link)
http://www.hss.caltech.edu/SSPapers/wp1070.pdf (application/pdf)
Our link check indicates that this URL is bad, the error code is: 404 Not Found (http://www.hss.caltech.edu/SSPapers/wp1070.pdf [301 Moved Permanently]--> https://www.hss.caltech.edu/SSPapers/wp1070.pdf)

Related works:
Journal Article: Basic Principles of Asset Pricing Theory: Evidence from Large-Scale Experimental Financial Markets (2004)
Journal Article: Basic Principles of Asset Pricing Theory: Evidence from Large-Scale Experimental Financial Markets (2004)
Working Paper: Basic Principles Of Asset Pricing Theory: Evidence From Large-Scale Experimental Financial Markets (2000)
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:clt:sswopa:1070

Ordering information: This working paper can be ordered from
Working Paper Assistant, Division of the Humanities and Social Sciences, 228-77, Caltech, Pasadena CA 91125

Access Statistics for this paper

More papers in Working Papers from California Institute of Technology, Division of the Humanities and Social Sciences Working Paper Assistant, Division of the Humanities and Social Sciences, 228-77, Caltech, Pasadena CA 91125.
Bibliographic data for series maintained by Victoria Mason ().