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Nonspeculative Bubbles Revisited: Speculation Does Matter

Steven Tucker () and Yilong Xu ()
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Steven Tucker: University of Waikato,
Yilong Xu: University of Heidelberg

Working Papers in Economics from University of Waikato

Abstract: Research in Finance has long been intrigued by the causes of price bubbles. It has been argued that investors having doubts about the rationality of others may speculate on future capital gains. However, in an important contribution, Lei et al. (2001) argue that speculation is not the driver of bubbles in the absence of common knowledge of rationality, suggesting a focus on mistakes and confusion. Indeed, interventions that reduce confusion, reduce the incidence of bubbles. Yet, it has been shown that this effect is likely due to these interventions also establishing common knowledge of rationality. This leaves a puzzle, when both speculation and confusion are excluded as an explanation for bubbles. We revisit Lei et al.’s (2001) design, confirming the existence of bubbles. However, we argue that, although their design removes the ability to speculate, it introduces several unintended design artifacts, inducing bubbles. We design a condition that eliminates any incentives for speculation without these effects. Bubbles are indeed eliminated in this treatment. We conclude that speculation plays a critical role in bubble formation, and thus does matter.

Keywords: speculation; bubbles; cognitive ability; asset market experiment (search for similar items in EconPapers)
JEL-codes: C91 G13 (search for similar items in EconPapers)
Pages: 25 pages
Date: 2020-09-17
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