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A Futures Market Reduces Bubbles but Allows Greater Profit for More Sophisticated Traders

Charles Noussair, Steven Tucker () and Yilong Xu

Working Papers in Economics from University of Waikato

Abstract: We study the effect of the addition of a futures market, in which contracts maturing in the last period of the life of the asset can be traded. Our experiment has two treatments, one in which a spot market operates on its own, and a second treatment in which a spot and futures market are active simultaneously. We find that the futures market reduces spot market mispricing among a trader population prone to bubbles, while having no effect on mispricing in a group not prone to it. Thus, overall, futures markets aid price discovery in the spot market, although the futures markets themselves exhibit considerable overpricing. Individuals with higher cognitive reflection test (CRT) scores achieve greater earnings, as they tend to sell in the overpriced futures market, while traders with lower CRT score make purchases in the futures market. We also consider the predictive power of an enhanced CRT measure (ECRT), which weightstwo types of incorrect answers differently.

Keywords: asset market experiment; market institution; futures market (search for similar items in EconPapers)
JEL-codes: C91 G13 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-exp
Date: 2014-10-13
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