Experiments in Finance
Paper Session
Saturday, Jan. 4, 2025 10:15 AM - 12:15 PM (PST)
- Chair: Sascha Füllbrunn, Radboud University
Credit Ratings and Investments
Abstract
We study how inflated credit ratings affect investment decisions in bond markets using experimental coordination games. Theoretical models that feature a feedback effect between capital markets and the real economy suggest that inflated ratings can have both positive and negative real effects. We compare markets with and without a credit rating agency and find that ratings significantly impact investor behaviour and capital allocation to firms. We show that the main mechanism through which these real effects materialize is a shift in investors’ beliefs about the behaviour of other investors rather than firms’ underlying fundamentals. Our experimental results suggest that the positive impact of inflated ratings is likely to dominate in the presence of feedback effects since ratings act as a strong coordination mechanism resulting in enhanced market outcomes.How General Equilibrium in Markets with Indivisible Goods Obtains Thanks to Complexity
Abstract
Indivisibilities in goods or services such as travel, insurance, cars, etc., have long been known to cause serious problems for (walrasian) equilibrium existence. One of the reasons is the assumption that agents fully optimize. This assumption is theoretically implausible and factually wrong since individual budget allocation problems under indivisibilities are "NP hard." Armed with recent advances into the drivers of human effort and performance in the 0-1 knapsack problem, we propose that markets may equilibrate after all because markets select price configurations that make agents' budget problems sufficiently difficult so that demand is stratified along levels of cognitive effort or capability. In a market experiment with 3 assets and cash, we find that markets settle -- regardless of whether the Walrasian equilibrium exists -- at price levels that imply high computational complexity. This leads to lower earnings for participants who use only simpler algorithms (heuristics) when determining which assets to buy.ETF Indexing Strategies and Asset Prices: Experimental Evidence
Abstract
We examine whether and how the indexing strategy used by ETFs affects prices of constituent assets in experimental markets. We study this issue in both the primary market (ETF creations and redemptions using bots as Authorized Participants) and in the secondary market (trades of existing ETF assets). The experiment includes three different environments: (i) no ETF index assets, (ii) an equal weighted ETF index asset, and (iii) a market cap weighted ETF index asset. We find that ETF products significantly affect the value of the constituent assets, and in particular the value of assets that are in shortest supply. For such assets, we find a much larger bid-ask spread when the ETF index asset is equally weighted than when it is weighted by market capitalization.Disposed to Be Overconfident
Abstract
We show that the disposition effect - the tendency of investors to hold losers and sell winners - can be a source of overconfidence. We consider empirical, experimental, and theoretical evidence. Based on survey data and transaction records, we show that Dutch retail investors who realized more gains than losses believe they have higher portfolio performance relative to other investors, even after controlling for their actual portfolio performance. In an experiment, individuals update beliefs about their own investment ability based on realized gains and losses rather than overall performance of their portfolio. And in a theoretical model in which investors update beliefs about their ability by attending to realized gains and losses, the disposition effect leads to overconfidence, low trading profits, and high volume.Discussant(s)
John Duffy
,
University of California-Irvine
Alec Smith
,
Virginia Tech
Steve Heinke
,
University of Fribourg
Peiran Jiao
,
Maastricht University
JEL Classifications
- G0 - General
- C9 - Design of Experiments