Another law of small numbers: patterns of trading prices in experimental markets
Patrick Roger and
Marc Willinger ()
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Tristan Roger: DRM-Finance - DRM - Dauphine Recherches en Management - Université Paris-Dauphine - CNRS - Centre National de la Recherche Scientifique
Wael Bousselmi: CREST - Centre de Recherche en Economie et Statistique [Bruz] - ENSAI - Ecole Nationale de la Statistique et de l'Analyse de l'Information [Bruz]
CEE-M Working Papers from CEE-M, Universtiy of Montpellier, CNRS, INRA, Montpellier SupAgro
Conventional finance models indicate that the magnitude of stock prices should not influence portfolio choices or future returns. This view is contradicted, however, by empirical evidence. In this paper, we report the results of an experiment showing that trading prices, in experimental markets, are processed differently by participants, depending on their magnitude. Our experiment has two consecutive treatments. One where the fundamental value is a small number (the small price market) and a second one where the fundamental value is a large number (the large price market). Small price markets exhibit greater mispricing than large price markets. We obtain this result both between-participants and within-participants. Our findings show that price magnitude influences the way people perceive the distribution of future returns. This result is at odds with standard finance theory but is consistent with: (1) a number of observations in the empirical finance and accounting literature; and (2) evidence in neuropsychology on the use of different mental scales for small and large numbers.
Keywords: number perception; mental scales; behavioral bias; experimental markets; stock price magnitude (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-exp and nep-mst
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