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Bubbles in the City?

This study delves into historical and laboratory-based bubbles in financial markets, exploring the dynamics of bubbles in assets like Tulipmania and the experimental simulation of trading behavior and private information among professional traders. The experiment examines gains from trade, private information transmission, and trading protocol within a controlled market setting. Results show no bubbles in the city, providing valuable insights for market professionals.

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Bubbles in the City?

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  1. Bubbles in the City? Very preliminary – Please do not cite M. Cipriani – R. De Filippis – A. Guarino – R. Kendall NYFRB UCLUCL UCL The views expressed herein are those of the authors and should not be attributed to the Federal Reserve Bank of New York or the Federal Reserve System. New YorkMay 2019

  2. Bubbles in Financial Markets Historical episodes of bubbles: Tulipmania; the Netherlands (“Dutch Republic”), 1636-37; South Sea Bubble, Mississipi Bubble; England, France, 1719-20; More recent episodes: Japan, 1980-90; Scandinavia, 1980; Etc.

  3. Bubbles in the Laboratory A much narrower perspective: Smith, Suchanek and Williams, Econometrica (1988). Palan (2010).

  4. The Experiment Our experiment is similar to Smith et al. (1988) but with three important differences: 1) subject pool of professional traders; 2) gains from trade; 3) private information.

  5. The Asset • Discrete time: t=1,2…,10. • • One asset paying a dividend at the end of each period: • • Dividends are i.i.d., with Pr(dt=150) = Pr(dt=50) = ½.

  6. Private Information (about Dividends) • Before trading startsin period t, dtis randomly determined and each subject receives private information about it. • If dt = 150, six subjects receive a “blue ball” and two receive a “red ball”. • If dt = 50, six subjects receive a “red ball” and two receive a “blue ball”. • Symmetric binary signal with precision 0.75. • Note: this is about the dividend in the “current period”, not in “future periods”.

  7. Gains from Trade • In each period t, half of the subjects pay a 50 ECU fee for each unit they hold in their portfolio at the end of the period. • That means that the actual payoff per unit held in the portfolio is either 150 or 50 for half of the subjects and either 100 or 0 for the other half. • The subjects required to pay a fee are randomly re-determined in every period.

  8. Trading Protocol 8 subjects in a market. Initial endowment: 3 units of the asset and 7000 cash (“ECU”). Continuous time double auction. 150 seconds per period. Subjects input buy and sell offers (bid and ask prices). Each transaction is for one unit of the asset. No short selling is allowed.

  9. Trading Protocol (continued) • Trade occurs when: • The highest bid price is greater than or equal to the lowest ask price. • The price at which a subject is willing to buy is higher than the price at which another subject is willing to sell. • Subjects click on “BUY” or “SELL” buttons, which automatically buy or sell at the best available price.

  10. Trading Platform

  11. End of Period The period ends after 150 seconds. Subjects learn the dividend value (either 150 or 50). The dividend (minus the fee, if applicable) is paid into their portfolio. The assets and cash held in their portfolio at the end of the previous period are the endowment for the next period. Subjects are paid based on their total ECU at the end of Period 10.

  12. Competitive REE In period 1, if d1 = 150, then P1 = 150 + 900 = 1050; if d1= 50, then P1= 50 + 900 = 950. In period 2, if d2= 150, then P2= 150 + 800 = 950; if d2= 50, then P2=50 + 800 = 850. ….. In period 10, if d10= 150, then P10= 150; if d10= 50, then P10= 50.

  13. Participants • Not the usual subjects in experimental economics / finance (undergraduate students). • Traders and portfolio managers working in the “City”. • Overall, 56 professionals, to run 7 independent sessions.

  14. Participants’ Characteristics

  15. Participants’ Characteristics

  16. Payoff Converted ECU into GBP at the rate £2.50 = 100 ECUs. Average payoff = £234.93 (approx. $300). Minimum: £121. Maximum: £401.33. S.D.: £40.53.

  17. Experimental Design What I described was the main treatment. Then we ran a control treatment with 56 UCL undergraduate students (88% males, 11% females). On average, 2 hour experiment. Today I am only discussing Phase 1 of the experiment (approximately 1 hour and 20 minutes). In a second phase (40 minutes) we collected data on cognitive abilities, strategic sophistication, non-cognitive abilities.

  18. Students’ Payoff Converted ECU into GBP at the rate £2.50 = 100 ECUs. (For students: £0.25 = 100 ECUs) Average payoff = £234.93. (£23.35) Minimum: £121. (£7.84) Maximum: £401.33. (£42.50) S.D.: £40.53. (£6.06)

  19. Results: Bubbles?

  20. Results: Bubbles? Traders Students

  21. Results: RAD and RD Mann-Whitney Test: RAD: p-value = 0.049 RD: p-value = 0.31

  22. Results: AllocativeEfficiency Proportions of assets held by subjects without fee:

  23. Results: Information Aggregation dt= 150 dt+1= 150 -100 dt = 150 dt+1 = 50 -200 dt = 50 dt+1 = 150 0 dt = 50 dt+1 = 50 -100 Distance from theoreticalpricechange: Mann-Whitney Test: p = 0.01

  24. Conclusion No bubbles in the City. Antonio should not eat his hat.

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