Bryan K. Church

Margin, Short Selling, and Lotteries in Experimental Asset Markets

The robustness of bubbles and crashes in markets for assets with finite lives 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 pay 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.

The effects of subject pool and design experience on rationality in experimental asset markets

Empirical evidence suggests that prices do not always reflect fundamental values and individual behavior is often inconsistent with rational expectations theory. We report the results of fourteen experimental asset markets designed to examine whether the interactive effect of subject pool and design experience (i.e., previous experience in a market under identical conditions) tempers price bubbles and improves forecasting ability. Our main findings are: 1) price run-ups are modest and dissipate quickly when traders are knowledgeable about financial markets and have participated in a previous market under identical conditions; 2) price bubbles moderate quickly when only a subset of traders are knowledgeable and experienced; 3) the heterogeneity of expectations about price changes is smaller in markets with knowledgeable and experienced traders, even if such traders only represent a subset of the market; and 4) individual forecasts of prices are not consistent with the predictions of the rational expectations model in any market, although absolute forecast errors are smaller for subjects who are knowledgeable of financial markets and for those subjects who have participated in a previous market. In sum, our findings suggest that markets populated by at least a subset of knowledgeable and experienced traders behave rationally, even though average individual behavior can be characterized as irrational.

An Experimental Study of Circuit Breakers: The Effects of Mandated Market Closures and Temporary Halts on Market Behavior

This paper analyzes the effect of circuit breakers on price behavior, trading volume, and profit-making ability in a market setting. We conduct nine experimental asset markets to compare behavior across three regulatory regimes: market closure, temporary halt, and no interruption. The presence of a circuit breaker rule does not affect the magnitude of the absolute deviation in price from fundamental value or trading profit. The primary driver of behavior is information asymmetry in the market. By comparison, trading activity is significantly affected by the presence of a circuit breaker. Mandated market closures cause market participants to advance trades.

Bubbles in Experimental Asset Markets: Irrational Exuberance No More

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.

The asset allocation decision and investor heterogeneity: a puzzle?

Abstract This paper examines portfolio allocation decisions for a large sample of demographically diverse survey respondents in light of finance theory and the recommendations of financial advisors. We investigate whether asset allocation decisions vary for respondents who differ across several dimensions including gender, home ownership, age, net worth, and psychological orientation. Sample respondents’ decisions are consistent with popular advice and finance theory. We find that only age affects the mix of risky securities. When we consider the allocation of total portfolio assets to equity, all individual characteristics except age matter. Psychological orientation contributes to our ability to explain asset allocation decisions.

Conflicts of Interest, Disclosure, and (Costly) Sanctions: Experimental Evidence

Conflicts of interest may compromise individuals’ independence in providing advisory services. Full disclosure is a commonly recommended remedy for the adverse effect of conflicts of interest. Yet prior study shows that disclosure may not have the intended effect because it provides individuals with moral license to engage in self‐interested behavior, thereby exacerbating biases. We follow up on this research and seek to determine whether other institutional factors may negate the potentially harmful effects of disclosure. We conduct a laboratory experiment, focusing on behavior in an investor/financial adviser dyad, including important representative features in this setting. Our results suggest that disclosure is not necessarily detrimental. We find that investors are better off when conflicts of interest are disclosed and sanctions are available, even though initiating sanctions is costly to investors. Under such conditions, advisers’ bias is dampened markedly.

Firm Image and Individual Investment Decisions

This paper documents the importance of firm image in individual investment behavior. We conduct three experiments designed to examine whether investment decisions are influenced by selective information disclosures that are intended to promote a positive or negative firm image. Importantly, the disclosures are not value-relevant. Participants actively make investment decisions that have real economic consequences. We find that participants invest more heavily in firms with a positive image than in firms with a negative image, controlling for industry membership and financial data. These results are consistent with economic models of choice that recognize that the financial outcome is not the only argument in a persons utility function.

Information dissemination and the distribution of wealth: Evidence from experimental asset markets

Abstract We conduct 24 experimental asset markets to investigate the effects of differentially informed and experienced agents on information dissemination and the distribution of wealth. In our markets private information is incomplete in that it reduces, but does not eliminate, state uncertainty. Private information is not fully disseminated, even in markets with experienced traders. Informed agents exploit their informational advantage and earn greater profit than uninformed agents, but only in markets with inexperienced traders. Lastly, uninformed agents earn greater profit when some agents are informed, but only in markets with experienced traders. Overall, uninformed agents benefit from design-specific trading experience.

Information Acquisition and Opportunistic Behavior in Managerial Reporting

Prior experimental studies have investigated factors affecting the honesty of managerial reporting in contexts where managers have no discretion in determining what information to acquire before making their reports. In many organizations, however, responsibility for acquiring information is delegated to local managers. Such delegated decision rights give managers discretion regarding what information to supply to the accounting system on which their reports are based. We predict that discretion may promote opportunistic reporting behavior because it allows managers to avoid relevant information and, in turn, report so as to maximize personal wealth without being knowingly untruthful. We investigate this prediction via two experiments. Results of Experiment 1 suggest that whether discretion in information acquisition affects reporting behavior is influenced by an individual’s preference for honesty (i.e., ethical type). We conduct Experiment 2 to investigate whether this is the case. Results show that, although discretion does not affect the reporting behavior of participants with low or high honesty preferences, participants with moderate honesty preferences tend to exploit discretion in order to avoid relevant information and report opportunistically. Our results suggest that the ability to exploit opportunities afforded by discretion in information acquisition is a potential cost when weighing the costs and benefits of assigning decision rights to managers. Our results also highlight the importance of considering a manager’s ethical type when assigning decision rights.

Biases in Individual Forecasts: Experimental Evidence

Trueman [1994] provides a model of forecasting behavior in which analysts do not always make forecasts that are consistent with their private information. Using Truemans model to provide theoretical direction, we conduct six experimental sessions to investigate individual forecasting behavior. In each session, four individuals predict earnings based on possibly divergent information. We manipulate forecast ability so that two individuals are strong analysts and two are weak. In three sessions, forecasts are released simultaneously. We find that forecasts do not always reflect private information. Both weak and strong analysts make forecasts that are inconsistent with private information, although the behavior is much more pronounced for weak analysts. In another three sessions, forecasts are released sequentially. We find that weak second analysts engage in herd behavior: that is, they mimic the reporting behavior of the first analyst. In contrast, strong second analysts are unaffected by the reporting behavior of the first analyst. The overall findings are consistent, in spirit, with the forecasting behavior suggested by Trueman [1994].