It is Not Just Confusion! Strategic Uncertainty in an Experimental Asset Market (original) (raw)

Asset prices and informed traders’ abilities: Evidence from experimental asset markets

Accounting, Organizations and Society, 2004

This study reports the results of fifteen experimental asset markets designed to investigate the effects of forecasts on market prices, traders' abilities to assess asset value, and the link between the two. Across the fifteen markets, the authors investigate alternative forecast-generating processes. In some markets the process produces an unbiased estimate of asset value and in others a biased estimate. The processes generating the biased forecasts, though, are less variable than the process generating the unbiased forecast. The authors find that, in general, periodend asset price reflects private forecasts, regardless of the forecast-generating process. Subsequently, they investigate whether traders' abilities to use forecasts differ across the forecast-generating processes. The authors find that most are able to properly use unbiased forecasts. They refer to them as smart traders. By comparison, a significant proportion is unable to properly use biased forecasts (typically traders' adjustments for bias are insufficient). Linking market outcomes and traders' abilities, the authors find that asset price appears to properly reflect unbiased forecasts as long as the market includes at least two smart informed traders who have sufficient ability to influence market outcomes. To obtain a comparable result in markets with the biased forecast, at least three smart informed traders with sufficient ability to influence market outcomes are necessary.

Behavioral uncertainty and the dynamics of traders’ confidence in their price forecasts

Journal of Economic Dynamics and Control, 2018

By how much does the presence of behavioral uncertainty in an experimental asset market reduce subjects' confidence in their price forecasts? An incentivized interval forecast elicitation method is employed to answer this question. Each market consists of six traders, and the value of dividends is known. Two treatments are considered: six human traders (6H), and one human interacting with five computer traders whose behavior is known (1H5C). We find that while the deviation of the initial price forecasts from the fundamental value is significantly smaller in the 1H5C treatment than in the 6H treatment, the average confidence regarding the forecasts is not. We further analyze the relationships between subjects' confidence in their forecasts and their trading behavior, as well as their trading performance, in the 6H treatment. While subjects' high confidence in their short-term forecasts shows a negative correlation with their trading performance, high confidence in their long-term forecasts shows a positive correlation with trading performance.

Confidence and decision-making in experimental asset markets

Journal of Economic Behavior & Organization, 2020

This paper examines how traders' confidence and market confidence affect outcomes in an experimental asset market with known fundamental values. In this type of market, prices usually present large deviations from the fundamental value; in other words, bubbles are known to occur. We measure beliefs by asking participants to forecast the one-periodahead price as a discrete probability mass distribution. We define confidence as the inverse of the dispersion of beliefs for each trader, and also create a market-wide measure of this to measure agreement across traders. We find that confidence affects price-formation and is also important in explaining the dynamics and size of the bubble. Moreover, as traders are successful they become increasingly certain of their beliefs, even if these beliefs are on non-fundamental values, thus increasing the likelihood of price bubbles.

Forecasting Skills in Experimental Markets: Illusion or Reality?

SSRN Electronic Journal, 2020

Using experimental asset markets, we study the situation of a financial analyst who is trying to infer the fundamental value of an asset by observing the market's history. We find that such capacity requires both standard cognitive skills (IQ) as well as social and emotional skills. However, forecasters with high emotional skills tend to perform worse when market mispricing is high as they tend to give too much emphasis to the noisy signals from market data. By contrast, forecasters with high social skills perform especially well in markets with high levels of mispricing in which their skills could help them detect possible manipulation attempts. Finally, males outperform females in the forecasting task after controlling for a large number of relevant individual characteristics such as risk attitudes, cognitive skills, emotional intelligence, and personality traits.

Cognitive Biases, Ambiguity Aversion and Asset Pricing in Financial Markets

SSRN Electronic Journal, 2000

We test to what extent financial markets trigger comparative ignorance (Fox and Tversky (1995)) when interpreting news, and hence, to what extent such markets instill ambiguity aversion in participants who do not really know how to correctly update. Our experiments build on variations of the Monty Hall problem, which, when tested on individuals separately, are well known to generate obstinacy: subjects often refuse to acknowledge that they are wrong. Under comparative ignorance, however, subjects who are not able to correctly solve Month-Hall-like problems should become ambiguity averse. In a financial markets context, we posit that such feeling of comparative ignorance emerges when traders, who do not have the correct solution, face prices that contradict their beliefs. Previous experiments with financial markets have shown that ambiguity aversion makes subjects hold portfolios that are insensitive to prices; subjects instead prefer to hold balanced portfolios, and hence, are not exposed to ambiguity. And because subjects are price-insensitive, they do not contribute to price setting. This led us to hypothesize that, when faced with Monty-Hall-like problems, (i) there would be subjects whose portfolio decisions are insensitive to prices, (ii) price quality would be inversely related to the proportion of price-insensitive subjects, (iii) price-insensitive subjects tend to choose more balanced portfolios (correcting for mispricing), and (iv) price-insensitive subjects trade less. Our experiments confirm these hypotheses. We do discover, however, the presence of a minority of price-sensitive subjects who simply tend to buy more as prices increase. We interpret the behavior of such subjects as herding, a hitherto unsuspected reaction to comparative ignorance. Altogether, our experiments suggest that cognitive biases may be expressed differently in a financial markets setting than in traditional single-subject experiments.

Diversity in cognitive ability and mispricing in experimental asset markets∗

2017

Does diversity in cognitive ability among market participants enlarges mispricing? Does the common knowledge of heterogeneity among the cognitive ability of market participants further enlarges the mispricing? We investigated these questions by first measuring subjects’ cognitive ability and categorizing them as ‘H’ type for those above median ability and ‘L’ type for those below median ability. We then constructed three kinds of markets with six traders each: 6H, 6L, and 3H3L. Subjects were informed of their own cognitive type and, depending on the treatment, also that of the others in their market. We found heterogeneous markets (3H3L) generated significantly larger mispricing than homogeneous markets (6H or 6L) regardless of whether subjects were informed about the cognitive type of others in the market. Thus, diversity in cognitive ability among market participants enlarged mispricing. However, common knowledge of heterogeneity or homogeneity did not have significant additional ...

Stock Market Investors: Who Is More Rational, and Who Relies on Intuition?

International Journal of Economics and Finance, 2012

Contemporary research documents various psychological aspects of economic and financial thought and decision-making. The main goal of our study is to analyze the effects of five well-documented behavioral biases, namely, disposition effect, herd behavior, availability heuristic, gambler's fallacy and hot hand fallacy, on the mechanism of stock market decision-making, and, in particular, the individual differences in the degrees of these effects. Employing an extensive online survey, we document that on average, active stock market investors exhibit moderate degrees of behavioral biases. Furthermore, we find that, on the one hand, more experienced investors are less affected by behavioral patterns, yet, on the other hand, professional portfolio managers do not behave, in this respect, differently (more rationally) from non-professional investors. We, therefore, infer that investor's experience in stock market matters, but not the "status" itself of being a professional, may decrease the effect of behavioral biases on her. In addition, we detect that the major "rationalizing" effect of experience is already accumulated in the first years of investors' stock market activity. Finally, we document that female investors are more strongly affected by all the five behavioral biases.

Attitude within the Context of Experimental Asset Markets∗

2016

This paper investigates (i) the robustness of hindsight bias in experimental asset markets, (ii) the time invariance of the different experimental risk elicitation methods of certainty equivalents and binary lottery choices, and (iii) their correspondence. The results of our within-subjects approach with 133 traders do not support the conjecture that hindsight bias is a general phenomenon. Furthermore, our findings challenge the presumption of time-stable risk preferences and of procedural invariance with respect to different experimental risk elicitation methods.