Bubbles in Experimental Asset Markets: Irrational Exuberance No More

Lucy F. Ackert, Narat Charupat, Bryan K. Church, and Richard Deaves
Working Paper 2002-24
December 2002

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The robustness of bubbles and crashes in markets for finitely lived assets is perplexing. This paper reports the results of experimental asset markets in which participants trade two assets. In some markets, price bubbles form. In these markets, traders will pay even higher prices for the asset with lottery characteristics, i.e., a claim on a large, unlikely payoff. However, institutional design has a significant impact on deviations in prices from fundamental values, particularly for an asset with lottery characteristics. Price run-ups and crashes are moderated when traders finance purchases of the assets themselves and are allowed to short sell.

JEL classification: C92, G14

Keywords: bubbles, asset markets, laboratory experiments, rational expectations

Financial support of the Federal Reserve Bank of Atlanta and Social Sciences and Humanities Research Council of Canada is gratefully acknowledged. The authors thank Steve Karan and Sule Korkmaz for research assistance; Steve Bendo and Sanjay Srivastava for technical assistance; and Peter Bossaerts, Ann Gillette, Charles Holt, Ferd Levy, and Ed Maberly for helpful comments. This paper has been presented in the Atlanta Finance Workshop, at the universities of Nebraska-Lincoln and Toronto, and at the 2002 meetings of the American Finance Association. The views expressed here are the authors’ and not necessarily those of the Federal Reserve Bank of Atlanta or the Federal Reserve System. Any remaining errors are the authors’ responsibility.

Please address questions regarding content to Lucy F. Ackert, Department of Economics and Finance, Michael J. Coles College of Business, Kennesaw State University, 1000 Chastain Road, Kennesaw, Georgia 30144, 770-423-6111, lucy_ackert@coles2.kennesaw.edu, and Research Department, Federal Reserve Bank of Atlanta, 1000 Peachtree Street N.E., Atlanta, Georgia, 30309-4470; Narat Charupat, Michael G. DeGroote School of Business, McMaster University, 1280 Main Street, West Hamilton, Ontario, Canada L8S 4M4, 905-525-9140 ext. 23987, charupat@mcmail.cis.mcmaster.ca; Bryan K. Church, DuPree College of Management, Georgia Tech, Atlanta, Georgia 30332-0520, 404-894-3907, bryan.church@mgt.gatech.edu; or Richard Deaves, Michael G. DeGroote School of Business, McMaster University, 1280 Main Street West Hamilton, Ontario, Canada L8S 4M4, deavesr@mcmaster.ca.