Asset Bubbles without Dividends – An Experiment

Jörg Oechssler (University of Heidelberg)Carsten Schmidt (SFB 504, Mannheim)

Wendelin Schnedler (University of Heidelberg)

What is a bubble?

• standard definition: persistent deviation of prices from fundamental values (+ high volume)

• is that all?

What is a bubble?• Robert Shiller‘s definition: • „...a situation in which news of price

increases spurs investor enthusiasm, which spreads by psychological contagion from person to person, in the process amplifying stories that might justify the price increases and bringing in a larger and larger class of investors, who despite doubt about the real value of an investment, are drawn to it partly through envy of others‘ successes and partly through a gambler‘s excitement.“

Inside information

Charts

Chat

measure beliefs!

Charts...

…chat, …

• millions of financial chat groups on the internet

• personal communication with friends, neighbors

• talk among professional traders

…chat, and inside information.

• „stories“ are made up to justify extreme price movements

• e.g. possibly someone has information that „ the new voice-over-IP technique of firm X will revolutionize the telephone market“

Bubble experiments

• Smith, Suchanek, Williams (1988)• austere environment• 15 periods• double auction• asset pays stochastic dividend in each

period, E(d) = 24• fundamental value = 24 * remaining

periods

• many replications• short-selling, 2 assets,

something else to do, etc.• only way to prevent bubbles:

experience in same market

Bubbles and dividends

• all experiments in which bubbles occur pay dividends in each period

• but...• many internet stocks never paid dividends

(Dell, Yahoo!, Oracle…), neither do commodities

• dividends paid out only once per year• good explanation for bubbles?• what if there are no dividends?

Our experiment

• what does it take to produce bubbles with constant fundamental values and only a final dividend?

• our conjecture: there are 2 ingredients:– possibility of inside information – possibility to observe others and

communicate with them

Our experiment

• possibility of inside information→ assets may pay supplements on top of usual

final dividends→ possibility that someone has private info

• possibility to observe others and communicate with them→ chat & charts

Experimental design

• 5 assets (traded sim.), double auction• 10 traders• only final dividend = base value + supplement• base value: U[50,90], E(d) = 70• 2 supplements: one asset 40, one asset 80• endowment: 10 units of each asset• plus 5000 units cash• plus 5000 units loan

Treatments INF: with prob. 0.5 one trader is informed

about one of the assets‘ supplements possibility for mirages, „see something when there is

nothing“, prior exp. by Camerer and Weigelt (1991) finds few mirages

INFCHAT: = INF + chat interface screen

NOINF: no trader knows which assets have supplements control treatment, do bubbles occur with constant

fundamentals and only final dividends?

Timing: a rounddraw od dividends

morning Chat

day 2

...morningChat

day 10

info aboutsupplement

morning Chat

afternoontrading

day 1

noonprediction

afternoon trading

noonprediction

afternoon trading

noonprediction

draw ofdividends

info aboutsupplement

Timing: a rounddraw od dividends

morning Chat

day 2

...morningChat

day 10

info aboutsupplement

morning Chat

afternoontrading

day 1

noonprediction

afternoon trading

noonprediction

afternoon trading

noonprediction

morning chat

afternoon- trading (2 min.)- chart

day 1

noonprediction(days 4, 6, 8)

• why prediction of dividend? speculation vs. confusion

Timing

• why 3 rounds?• experience effects (e.g. Dufwenberg et al.)• 6 sessions per treatment

practice round 1 round 2 round 3 questionnaireround

Results

Are there bubbles w/o dividends?

→ simple answer: yes

What drives them?→ inside information: yes→ chat: no! (just the opposite)

Bubble classification

• mirage: prices substantially above fundamental value, could be justified by information on supplement - but is not

• asset bubble: price deviation which cannot be justified by any possible information (unlikely to happen in our setting – or in reality)

1 2 3 4 5 6 7 8 9 10trading_day

90

120

150

180

210

med

ian

pric

es

Example for an asset bubble

above 150prices cannot bejustified by anyinformation onsupplements

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Bubble classification

• mirage: prices substantially above fundamental value, could be justified by information on supplement - but is not

• asset bubble: price deviation which cannot be justified by any possible information (unlikely to happen in our setting – or in reality)

• market bubble: price index of 5 assets deviates from fundamental value

70

110

150

190

70

110

150

190

70

110

150

190

70

110

150

190

1 2 3 4 5 6 7 8 910trading_day

70

110

150

190

nice convergence to a priori fundamental value of 94...

... and 150.Information onsupplement correctlyrevealed

But didn‘t adjust expectedvalue for other assets→ market bubble(but no asset bubble)

back

Bubble countbubble type

NOINF INF INFCHAT

mirage n.a. in 12 of 18 rounds

5 / 18

market bubble

4 / 18 11 / 18 3 / 18

asset bubble

(0 / 18) 3 / 18 0 / 18

• no indication that later rounds produce fewer bubbles

Explanatory variable:prob. of bubble round

Base modelwith

shortsalewith

confidence

INFCHAT -0.342** -0.288** -0.324**NOINF -0.354** -0.335*** -0.351**financial knowledge -0.791 -0.726* -0.727male 0.053 0.012 0.003upper division 0.154 0.201 0.314economics 2.896** 2.917** 2.772**business -0.477 -0.155 0.299law 4.778*** 4.645*** 4.678***sciences 2.385* 2.303* 2.305shortsale 0.725top-rank belief 0.171**Observations 54 54 54Log-Likelihood -20.519 -19.150 -19.945Pseudo R² 0.403 0.443 0.420

Probit random effects model

# of subjects who believe that they are going to be top trader in treatment

Overconfidence and experience• overconfidence in INF and

NOINF increasing with experience

• not so for INFCHAT

• does chat moderate overconfidence?

= sign. diff. from 1 at p < 0.02 level

Why is chat counterproductive for bubble formation?

• twice as many chat messages in non-bubble rounds)

• chat may point out overvaluation of market or assets

• chat may explain market mechanics (prevent misunderstanding)

• find examples for both

Speculation or confusion?

• speculation: know that asset is overpriced but speculate on even higher prices to sell

• confusion: don‘t recognize mispricing • which is it?

Speculation or confusion?price at end of this day

fundamental value

Speculation or confusion?

In bubbles rounds:

Big difference betweenexpected price after this day and expecteddividend

→ favors speculation hypothesis

Are prices fully revealing (REE)?

Comparison of final prices to REE pricesinfo about supplement 80 40 0 -40 -80

REE prediction 150 110 94 90 80

median of final prices in rounds 140 95 98 91.5 93.5

number of obs. 16 4 170 16 64

Tactics of insiders

• How do insiders trade?• want to profit from their info without giving

it away• may try to mislead non-insiders

Tactics of insiders

• no insider sold insider assets in first trade• 50% of first trades were limit bids for

insider asset• 20% were market bids for insider asset• 30% were orders for other assets

The slow build-upM

ean

hold

ings

of i

nsid

er a

sset

s by

insi

ders

Timing and prices of bids(by insiders for insider asset)

in seconds

in seconds

Frequency of bidsother bids by insiders for insider asset

Conclusion

• bubbles without dividends are possible• but additional factor necessary:

– possibility that someone has inside information

• chat: counterproductive?

Thank you for your attention

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