Financial Bubbles, Common Knowledge and Alternative Accounting Regimes: An Experimental Analysis of Artificial Spot Security Markets

Larry Bensimhon and Yuri Biondi
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Larry Bensimhon: Laboratoire Interdisciplinaire de Rechrche en Sciences de l’Action (LIRSA), Conservatoire National des Arts et Mètiers, France

The Japanese Accounting Review, 2013, vol. 3, 21-59

Abstract: We experimentally explore how common knowledge provided by accounting systems affects investors' decision and shapes the formation of security prices over time. We design alternative accounting structures and run experiments in artificial security markets framed by these structures. In sessions where investors receive exogenous accounting information about ultimate earnings, prices converge to the fundamental levels derived from those earnings through backward induction. Accounting plays a role for the market. In sessions where investors receive endogenous accounting information about earnings that are linked to the ongoing clearing price of the security, market price levels and paths become indeterminate and lose earnings anchor; investors tend to form their expectations of future prices by forward, not backward, induction. Accounting plays its role from the market, and loses its relevance in financial decision-making. These laboratory results suggest that accounting information and its overarching structure are important to prevent market exuberance, excess volatility and the formation of financial bubbles. They further have relevant effects on market allocative efficiency, and revenue and wealth distribution among investors.

Keywords: Share Price Bubbles; Market Exuberance; Excess Volatility; Short-term Investors; Backward Induction; Forward Induction; Experimental Financial Markets; Fair Value; Mark-to-Market; Accounting Regime (search for similar items in EconPapers)
JEL-codes: C9 D4 G1 G12 M41 M48 (search for similar items in EconPapers)
Date: 2013
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Citations: View citations in EconPapers (3)

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