Stacking Subsidies in Factor Markets: Evidence from Market Experiments

Government policies employ different support programs such as subsidies to reduce risks, increase efficiency in markets, and enhance societal welfare. In markets such as ethanol markets, where multiple agents receive subsidy, it is often difficult to determine whether recipients of these support programs will transfer some of their payments to other agents in the market. In this study, we use laboratory market experiments to understand subsidy incidence in markets where both buyers and sellers receive subsidies, and there are few buyers relative to sellers. Our results show that when subsidizing both sides of the market, framing effects matter, and when markets are buyer concentrated, subsidy distributions generally tend to favor buyers. With a per-unit subsidy of 20 tokens to both sides and an equal number of buyers and sellers in the market, we find that buyers increase their earnings by 13.4% while seller earnings decrease by 16.1%. On a per-schedule basis, buyer earnings in the concentrated market are similar to what we observed in the competitive market.

Neoclassical Supply and Demand, Experiments, and the Classical Theory of Price Formation

Neoclassical price theory was founded on axioms of price-taking behavior and the law of one price in a market, axioms inconsistent with a theory of endogenous price discovery in markets. Classical economists including Adam Smith narrated a price discovery process based on buyer and seller reservation values and their motivation to buy low and sell high; the classical sketch of price formation offers a quite fruitful foundation for a modern theory of price discovery, supplied below. Market experiments, based on private distributed reservation values and using rules governing open-outcry double auctions, converged endogenously, in three to four periods of repeat interaction, to an efficient outcome. These observations contradicted the widely believed, thought, and taught necessity for perfect information, large numbers, and price-taking behavior. However, these results were consistent with the old, classical, conception of price formation emerging from the collective interaction of the traders. Aggregation and price discovery constitute essential functions of classical markets. We explore the divergence of neoclassical scholars from this classical tradition. Revealingly, in describing the microdynamics of market price formation, prominent neoclassical utilitarians such as Marshall, with his description of a “corn-market in a county town,” and Böhm-Bawerk with his farmers’ horse market, reverted to this classical reservation-value framework.

Cognitive Variability Matches Speculative Price Dynamics

Price series in speculative markets show a common set of statistical properties, termed ‘stylised facts’. While some facts support simple efficient markets composed of homogenous rational agents (e.g., the absence of autocorrelation in price increments), others do not (e.g., heavy-tailed distributions of price changes and volatility clustering) (Campbell et al., 1997; Fama, 1970; Mandelbrot, 1966; Mandelbrot, 1963; Cont, 2001). Collectively, these facts have been explained by either more complex markets or markets of heterogeneous agents (Cont 2007; Giardina & Bouchaud, 2003; Hommes, 2006; Barberis & Thaler, 2005), with asset-market experiments validating the latter approach (Hommes 2011; Kirchler & Huber, 2009). However, it is unknown whether markets are necessary to produce these features. Here we show that within-individual variability alone is sufficient to produce many of the stylised facts. In a series of experiments, we increasingly simplified a price prediction task by first removing external information, then removing any interaction between participants. Finally, we removed any resemblance to an asset market by asking participants to simply reproduce temporal intervals. All three experiments produced the main stylised facts. The robustness of the results across tasks suggests a common cognitive-level mechanism underlies these patterns, and we identify a candidate that is a general-purpose approximation to rational behavior. We recommend a stronger focus on individual psychology in macroeconomic theory, and particularly within-individual variability. Combining these insights with existing economic mechanisms could help explain price changes in speculative markets.

How Much Information Is Incorporated into Financial Asset Prices? Experimental Evidence

We investigate the informational content of prices in financial asset markets. To do so, we use a large number of market experiments in which the amount of information held by traders is precisely observed. We derive a new method to estimate how much of this information is incorporated into market prices. We find that public information is almost completely reflected in prices but that surprisingly little private information—less than 50%—is incorporated into prices. Our estimates therefore suggest that, while semistrong informational efficiency is consistent with the data, financial market prices may be very far from strong-form efficiency.

Designing Call Auction Institutions to Eliminate Price Bubbles: Is English Dutch the Best?

The bubble-and-burst pattern in asset markets is among the most replicable results in experimental economics. Using controlled laboratory experiments, we compare mispricing in markets organized by standard double auction rules with mispricing in markets organized by two alternative sets of clock auctions. The double Dutch auction, shown to be more efficient than the double auction in past commodity market experiments, does not eliminate bubbles. However, the English Dutch auction yields prices reflective of underlying fundamentals and succeeds in taming bubbles even with inexperienced traders in a declining fundamental value environment with an increasing cash-to-asset ratio. (JEL C91, D44, G12)

Financial risk-taking related to individual risk preference, social comparison and competition

PurposeThe purpose of this paper is to investigate how social comparison and motivation to compete account for elevated risk-taking in fund management corroborated by asset market experiments when performance depends on rank-based incentives.Design/methodology/approachIn two laboratory experiments, university students (n1 = 240/n2 = 120) make choices between risky and certain outcomes of hypothetical sums of money. Both experiments investigate in which direction risky choices in an individual condition (individual risk preference) are shifted when participants compare their performance to another participant's performance (social comparison), being instructed or not to outperform the other (incentive to compete).FindingsIn the absence of incentives to compete, participants tend to minimize the differences between expected outcomes to themselves and to the other, but when provided with incentives to compete, they tend to maximize these differences. An independent additional increase in risk-taking is observed when participants are provided with incentives to compete.Originality/valueOriginal findings include that social comparison does not evoke motivation to compete unless incentives are offered and that increases in risk-taking depend both on what the other chooses and the incentives.