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Bubbles, Crashes, and Endogenous Expectations in Experimental Spot Asset Markets

Vernon L. Smith
Gerry L. Suchanek
Arlington W. Williams

Abstract

Spot asset trading is studied in an environment in which all investors receive the same dividend from a known probability distribution at the end of each of T = 15 (or 30) trading periods. Fourteen of twenty-two experiments exhibit price bubbles followed by crashes relative to intrinsic dividend value. When traders are experienced this reduces, but does not eliminate, the probability of a bubble. The regression of changes in mean price on lagged excess bids (number of bids minus the number of offers in the previous period), P"t - P"t-1 = @a = @b(B"t"-"1 - O"t"-"1), supports the hypothesis that -@a = E(d), the one-period expected value of the dividend, and that @b > O, where excess bids is a surrogate measure of excess demand arising from homegrown capital gains (losses) expectations. Thus when (B"t"-"1 - O"t"_"1) goes to zero we have convergence to rational expectations in the sense of Fama (1970), that arbitrage becomes unprofitable. The observed bubble phenomenon can also be interpreted as a form of temporary myopia (Tirole, 1982) from which agents learn that capital gains expectations are only temporarily sustainable, ultimately inducing common expectations, or "priors" (Tirole, 1982). Four of twenty-six experiments, all using experienced subjects, yield outcomes that appear to the "chart's eye" to converge "early" to rational expectations, although even in these cases we get @b > O, and small price fluctuations of a few cents that invite "scalping."