Thar She Bursts: Reducing Confusion Reduces Bubbles

Michael Kirchler, Jurgen Huber and Thomas Stockl

American Economic Review, 2012, vol. 102, issue 2, 865-83

Abstract: To explore why bubbles frequently emerge in the experimental asset market model of Smith, Suchanek, and Williams (1988), we vary the fundamental value process (constant or declining) and the cash-to-asset value ratio (constant or increasing). We observe high mispricing in treatments with a declining fundamental value, while overvaluation emerges when coupled with an increasing C/A ratio. A questionnaire reveals that the declining fundamental value process confuses subjects, as they expect the fundamental value to stay constant. Running the experiment with a different context ("stocks of a depletable gold mine" instead of "stocks") significantly reduces mispricing and overvaluation as it reduces confusion. (JEL C91, D14, G11, G12)

Date: 2012
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