Thar She Blows: Can Bubbles Be Rekindled with Experienced Subjects?

Adding significant liquidity to an environment can rekindle bubbles?

Abstract (Via Reshmaan N. Hussam, David Porter and Vernon L. Smith)

We report 28 new experiment sessions consisting of up to three experience levels to examine the robustness of learning and ‘error’ elimination by participants in a laboratory asset market and its effect on price bubbles. Our answer to the title question is: “yes.” We impose a large increase in liquidity and dividend uncertainty to shock the environment of experienced subjects who have converged to equilibrium, and this treatment rekindles a bubble. However, in replications of that challenging environment across three experience levels we discover that the environment yields a rare residual tendency to bubble even in the third experience session. Therefore, a caveat must beplaced on the effect of twice experienced subjects in asset markets: in order for price bubbles to be extinguished, the environment in which the participants engage in exchange must be stationary and bounded by a range of parameters. Experience, including possible ‘error’ elimination, is not robust to major new environment changes in determining the characteristics of a price bubble.

Article Excerpts (Via Reshmaan N. Hussam, David Porter and Vernon L. Smith)

But the only condition that has reliably eliminated price bubbles in these environments and yielded convergence toward fundamental value is increased experience in the same environment. In particular, SSWand subsequent replications found that common group experience, that is, the same cohort of traders, who can see they are the same, causes trading to thin out and contract prices to converge toward fundamental value by the third replication of the market.

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25. July 2009 by Miguel Barbosa
Categories: Curated Readings, Finance & Investing | Leave a comment

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