Saturday, December 13, 2008
Even in perfect lab conditions, markets tend towards bubbles
For more than two decades economists have been running this experiment. They take a bunch of volunteers and give each person money and bonds to trade with. The bonds have a risk-free dividend and a clear fundamental value. All participants are given the same information, but they can’t talk to one another and they interact only through their trading screens. Then the researchers watch what happens. Because the bond has a clear dividend, the trading price should stick close to the expected value. But that’s not what happens. Again and again, in experiment after experiment, the trading price runs up way above fundamental value. Then it crashes. Bubbles happen, even in the most controlled conditions.