Herding and Speculation in Experimental Asset Markets

I conduct an experiment to observe individual traders’ beliefs and desired behavior in a partial-equilibrium asset market. Isolated traders trade a risky asset in a market with exogenous prices. The price series exhibits a "bubble," diverging strongly from the expected dividend yield. Before trading, traders predict the asset’s price in the upcoming period, the price in the …nal period, and the asset’s current fundamental value. I …nd that beliefs about fundamentals are strongly in‡uenced by observed price movements, even when the stochastic process governing the fundamental is perfectly known. This suggests the possibility of herd behavior in experimental asset markets. Beliefs about both upcoming and …nal-period prices closely track observed prices, even for traders who understand the fundamental value. Price predictions diverge strongly from predictions of fundamentals, demonstrating that traders do not believe in market rationality in the short-term or long-term. A clear relationship between asset demand and beliefs cannot be determined, even when beliefs are highly accurate. Asset demand is strongly positive just after the peak of the bubble, and turns strongly negative only in the …nal period. The …ndings imply that market prices, instead of aggregating traders’ information, may provide traders with misinformation. This in turn may contribute to the phenomenon of asset bubbles.