nep-exp New Economics Papers
on Experimental Economics
Issue of 2007‒01‒13
nine papers chosen by
Daniel Houser
George Mason University

  1. Financial Engineering and Rationality: Experimental Evidence Based on the Monty Hall Problem By Brain Kluger; Daniel Friedman
  2. The power of words in financial markets: soft versus hard communication,a strategy method experiment By Corgnet Bruce; Angela Sutan; Arvin Aashta
  3. Short Sale Constraints, Divergence of Opinion and Asset Values: Evidence from the Laboratory By Gerlinde Fellner; Erik Theissen
  4. The dynamics of trader motivations in asset bubbles By Gunduz Caginalp; Vladimira Ilieva
  5. Experimental Evidence on the Benefits of Eliminating Exchange Rate Uncertainties and Why Expected Utility Theory causes Economists to Miss Them By Robin Pope; Reinhard Selten; Sebastian Kube; Jürgen von Hagen
  6. Experiential Learning and the Effectiveness of Economic Simulation Games By Bernhard Herz; Wolfgang Merz
  7. The Information Basis of Matching with Propensity Score By Maasoumi, Esfandiar; Eren, Ozkan
  8. Testing the rationality assumption using a design difference in the TV game show 'Jeopardy' By Sjögren Lindquist, Gabriella; Säve-Söderbergh, Jenny
  9. Level-k Auctions: Can a Non-Equilibrium Model of Strategic Thinking Explain the Winner's Curse and Overbidding in Private-Value Auctions? By Vincent Crawford; Nagore Iriberri

  1. By: Brain Kluger; Daniel Friedman
    Abstract: Financial engineering often involves redefining existing financial assets to create new financial products. This paper investigates whether financial engineering can alter the environment so that irrational agents can quickly learn to be rational. The specific environment we investigate is based on the Monty Hall problem, a well-studied choice anomaly. Our results show that, by the end of the experiment, the majority of subjects understand the Monty Hall anomaly. Average valuation of the experimental asset is very close to the expected value based on the true probabilities.
    Keywords: experiment, behavioral finance
    JEL: C90
    Date: 2006–07
  2. By: Corgnet Bruce; Angela Sutan; Arvin Aashta
    Abstract: The main objective of this paper is to analyze the impact of non-informative communications on asset prices. An experimental approach allows us to control for the release of non-relevant messages. We introduce the release of messages in standard experimental asset markets with bubbles (Smith, Suchanek and Williams 1988) through a strategy method experiment. We conjecture that a priori uninformative messages can significantly impact the level of asset prices. Uninformative communications may be used by boundedly rational subjects to compute the fundamental value of the asset. In addition, rational agents may anticipate such an effect and adapt their strategy to the messages received. We asked 182 subjects to construct strategies about their action in a standard experimental asset market environment. Our analysis sheds light on the possibility of manipulation and stabilization of financial markets by influential agents such as financial “gurus” or central bankers.
    Keywords: experiment
    JEL: C90
    Date: 2006–06
  3. By: Gerlinde Fellner; Erik Theissen
    Abstract: The overvaluation hypothesis (Miller 1977) predicts that a) stocks are overvalued when there are short selling restrictions and that b) the overvaluation is increasing in the degree of divergence of opinion. We design an experiment that allows us to test these predictions in the laboratory. Our results support the hypothesis that prices are higher in the presence of short selling constraints. The overvaluation does not depend on the degree of divergence of opinion.
    Keywords: overvaluation hypothesis, short selling constraints, divergence of opinion
    JEL: C92 G14
    Date: 2006–09
  4. By: Gunduz Caginalp; Vladimira Ilieva
    Abstract: Asset market experiments are analyzed by distinguishing, ex post facto, participants who trade on fundamentals versus those who trade on momentum (i.e., buying when the price is rising). The distinction is made when prices are above fundamental value, so that (in each period) those who have more offers than bids (net offerers) are classified as fundamentalists while those who have more bids than offers (net bidders) are defined to be momentum players. By analyzing the data of individual behavior we are able to address a number of key questions regarding bubbles. We find evidence that the cash supply of the momentum traders diminishes and the cash supply of the fundamental traders increases as the bubble forms. This suggests that the bubble is fueled by the cash of the momentum players and the reversal is caused by inadequate cash in their possession. These data are used in conjunction with a difference equation for price dynamics for two groups. The momentum traders exhibit a positive coefficient for price derivatives and a very small negative coefficient for trading based upon the deviation from fundamental value. Surprisingly, however, the fundamental traders, who exhibit a positive coefficient for trading on valuation, also exhibit a significantly positive coefficient for trend based buying. Thus, even those who are net offerers, classified as fundamentalists, are selling less and buying more of overvalued stock when there is a strong positive recent price change. There is also evidence that some fundamentalists change strategy to momentum trading as prices soar. An additional result is that the trend coefficient of the momentum traders vanishes with the implementation of an “open book” that allows traders to see all trades as they are entered.
    Keywords: Experimental economics, Asset markets, Behavioral finance, Momentum traders, Fundamental traders
    JEL: G12 C90
    Date: 2006–08
  5. By: Robin Pope; Reinhard Selten; Sebastian Kube; Jürgen von Hagen
    Abstract: Conclusions favourable to flexible exchange rates typically accord with expected utility theory in ignoring the costs that exchange rate uncertainty generates for governments, central banks, firms and unions in: (i) choosing among available acts; and (ii) existing until learning the outcome of the chosen act. Allowing for these costs involves the stages of knowledge ahead framework, Pope (1983, 1995, 2005). A laboratory experiment suggests that (i) and (ii) together outweigh the advantages of having a flexible exchange rate as an additional instrument for managing a country’s employment, interest rate, price level and international competitiveness goals
    Keywords: experiment
    JEL: C90
    Date: 2006–10
  6. By: Bernhard Herz; Wolfgang Merz
    Abstract: Kolb's theory of experiential learning provides a natural setting to evaluate simulation games. In this article, an experimental design is developed to test whether economic simulation games support the learning process corresponding to Kolb's experiential learning cycle. The empirical results indicate that simulation games support the four learning stages more efficiently than traditional teaching methods.
    Keywords: economic simulation games, learning through simulation/gaming, experiential learning, evaluation of simulation games, experimental assessment of teaching techniques, effectiveness of simulation games
  7. By: Maasoumi, Esfandiar (SMU); Eren, Ozkan (SMU)
    Abstract: This paper examines the foundations for comparing individuals and treatment subjects in experimental and other program evaluation contexts. We raise the question of multiattribute "characterization" of individuals both theoretically and statistically. The paper examines the information basis of characterizing individuals and offers alternatives motivated by welfare and decision theories. The proposed method helps place propensity scores and other "matching" proposals in context and reveals their advantages and disadvantages. We do not find the implied theoretical assumptions underlying propensity scores to be attractive or robust. Our proposal does not "solve" the matching problem, but provides bounds on inferences and makes clear the arbitrariness of specific solutions.
    Keywords: treatment effect; information theory; multivariate scaling; propensity scores; utility functions; fundamentalism; Kullback-Leibler; entropy; aggregation.
    JEL: F18 Q4
    Date: 2006–12
  8. By: Sjögren Lindquist, Gabriella (Swedish Institute for Social Research, Stockholm University); Säve-Söderbergh, Jenny (Swedish Institute for Social Research, Stockholm University)
    Abstract: This paper empirically investigates the rationality assumption commonly applied in economic modeling by exploiting a design difference in the game-show Jeopardy between the US and Sweden. In particular we address the assumption of individuals’ capabilities to process complex mathematical problems to find optimal strategies. The vital difference is that US contestants are given explicit information before they act, while Swedish contestants individually need to calculate the same information. Given a rationality assumption of individuals computing optimally, there should be no difference in the strategies used. However, in contrast to the rational and focal bidding behaviors found in the US, the Swedish players display no optimal behavior. Hence, when facing too complex decisions, individuals abandon optimal strategies.
    Keywords: Rationality; Bounded Rationality; Field Experiments
    JEL: C72 C93 D81
    Date: 2006–12–28
  9. By: Vincent Crawford (University of California, San Diego); Nagore Iriberri (University of California, San Diego)
    Abstract: This paper proposes a structural non-equilibrium model of initial responses to incomplete-information games based on "level-k" thinking, which describes behavior in many experiments with complete-information games. We derive the model's implications in first- and second-price auctions with general information structures, compare them to equilibrium and Eyster and Rabin's (2005) "cursed equilibrium," and evaluate the model's potential to explain behavior in auction experiments. The level-k model generalizes many insights from equilibrium auction theory. It also allows a unified explanation of the winner's curse in common-value auctions and overbidding in those independent-private-value auctions without the uniform value distributions used in most experiments.
    Keywords: common-value auctions, winner's curse, overbidding, bounded rationality, level-k model, non-equilibrium strategic thinking, behavioral game theory, experiments,
    Date: 2005–11–01

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