Expectations Structure in Asset Pricing Experiments

Giulio Bottazzi and Giovanna Devetag

LEM Papers Series from Laboratory of Economics and Management (LEM), Sant'Anna School of Advanced Studies, Pisa, Italy

Abstract: Notwithstanding the recognized importance of traders expectations incharacterizing the observed market dynamics, for instance theformation of speculative bubbles and crashes on financial markets,little attention has been devoted so far by economists to a rigorousstudy of expectation formation in the laboratory. In this work wedescribe a laboratory experiment on the emergence and coordination ofexpectations in a pure exchange framework. We largely base our studyon previous experiments on expectation formation in a controlledlaboratory environment by Cars Hommes, Joep Sonnemans, Ian Tuinstraand Henk van de Velden (CeNDEF Working Paper, Amsterdam, 2002). Weconsider a simple two asset economy with a riskless bond and a riskystock. Each market is composed of six experimental subjects who act asfinancial advisors of myopic risk-averse utility maximizing investorsand are rewarded according to how well their forecasts perform in themarket. The participants are asked to predict not only the price ofthe risky asset at time t+1, as in Hommes et al., but also theconfidence interval of their prediction, knowing the past realizationsof the price until time t-1. The realized asset price is derived fromaWalrasian market equilibrium equation, unknown to the subjects, withfeedback from individual forecasts. Subjects earnings are proportionalto the increase in their wealth level. With respect to previousexperiments that did not include an explicit evaluation of risk byparticipants, we observe a higher price volatility, a decreasedlikelihood of bubble dynamics and, in general, a higher heterogeneityof predictions.

Keywords: Experimental Economics; Expectations; Coordination; Asset pricing (search for similar items in EconPapers)
Date: 2003-12-21
New Economics Papers: this item is included in nep-exp, nep-rmg and nep-tid
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

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Related works:
Working Paper: Expectations Structure in Asset Pricing Experiments (2008)
Chapter: Expectations Structure in Asset Pricing Experiments (2005)
Working Paper: Expectations structure in asset pricing experiments (2005)
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