Stock market bubbles in the laboratory

David Porter and Vernon Smith ()

Applied Mathematical Finance, 1994, vol. 1, issue 2, 111-128

Abstract: Trading at prices above the fundamental value of an asset, i.e. a bubble, has been verified and replicated in laboratory asset markets for the past seven years. To date, only common group experience provides minimal conditions for common investor sentiment and trading at fundamental value. Rational expectations models do not predict the bubble and crash phenomena found in these experimental markets; such models yield only equilibrium predictions and do not articulate a dynamic process that converges to fundamental value with experience. The dynamic models proposed by Caginalp et al. do an excellent job of predicting price patterns after calibration with a previous experimental bubble, given the initial conditions for a new bubble and its controlled fundamental value. Several extensions of this basic laboratory asset market have recently been undertaken which allow for margin buying, short selling, futures contracting, limit price change rules and a host of other changes that could effect price formation in these assets markets. This paper reviews the results of 72 laboratory asset market experiments which include experimental treatments for dampening bubbles that are suggested by rational expectations theory or popular policy prescriptions.

Keywords: experimental economics; rational expectations; financial bubbles; futures contracting; insidertrading; dynamical systems (search for similar items in EconPapers)
Date: 1994
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Citations: View citations in EconPapers (46)

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DOI: 10.1080/13504869400000008

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