Compensation schemes, liquidity provision, and asset prices: an experimental analysis

Sascha Baghestanian (), Paul Gortner () and Baptiste Massenot ()
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Sascha Baghestanian: Goethe University Frankfurt
Paul Gortner: Goethe University Frankfurt
Baptiste Massenot: Goethe University Frankfurt

Experimental Economics, 2017, vol. 20, issue 2, No 9, 505 pages

Abstract: Abstract In an experimental setting in which investors can entrust their money to traders, we investigate how compensation schemes affect liquidity provision and asset prices, two outcomes that are important for financial stability. Compensation schemes can drive a wedge between how investors and traders value the asset. Limited liability makes traders value the asset more than investors. To limit losses, investors should thus restrict liquidity provision to force traders to trade at a lower price. By contrast, bonus caps make traders value the asset less than investors. This should encourage liquidity provision and increase prices. In contrast to these predictions, we find that under limited liability investors increase liquidity provision and asset price bubbles are larger. Bonus caps have no clear effect on liquidity provision and they fail to tame bubbles. Overall, giving traders skin in the game fosters financial stability.

Keywords: Compensation; Liquidity; Experimental asset markets; Bubbles (search for similar items in EconPapers)
JEL-codes: C90 C91 D03 G02 G12 (search for similar items in EconPapers)
Date: 2017
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Citations: View citations in EconPapers (4)

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DOI: 10.1007/s10683-016-9493-0

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