Title

The Effects of Subject Pool and Design Experience on Rationality in Experimental Asset Markets

Department

Economics, Finance, & Quantitative Analysis

Document Type

Article

Publication Date

3-2001

Abstract

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.