Asset Bubbles without Dividends – An Experiment

1. Asset Bubbles without Dividends – An Experiment Jörg Oechssler (University of Heidelberg) Carsten Schmidt (SFB 504, Mannheim) Wendelin Schnedler (University of Heidelberg)

2. What is a bubble? • standard definition: persistent deviation of prices from fundamental values (+ high volume) • is that all?

3. What is a bubble? • Robert Shiller‘s definition: • „...a situation in which news of price increases spurs investor enthusiasm, which spreads by psychological contagion fromperson 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.“ Chat Inside information Charts measure beliefs!

4. Charts...

5. …chat, … • millions of financial chat groups on the internet • personal communication with friends, neighbors • talk among professional traders

6. …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“

7. 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

9. many replications • short-selling, 2 assets, something else to do, etc. • only way to prevent bubbles: experience in same market

10. 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?

11. 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

12. 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

13. 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

14. 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?

15. morning Chat afternoon trading noon prediction day 1 draw of dividends info about supplement Timing: a round draw od dividends afternoon trading afternoon trading morning Chat noon prediction morning Chat noon prediction info about supplement ... day 2 day 10

16. morning Chat afternoon trading noon prediction day 1 morning chat • afternoon • trading • (2 min.) • - chart noon prediction (days 4, 6, 8) day 1 Timing: a round draw od dividends afternoon trading afternoon trading morning Chat noon prediction morning Chat noon prediction info about supplement ... day 2 day 10 • why prediction of dividend? speculation vs. confusion

17. Timing practice round 1 round 2 round 3 questionnaire round • why 3 rounds? • experience effects (e.g. Dufwenberg et al.) • 6 sessions per treatment

18. Results

19. Are there bubbles w/o dividends? • simple answer: yes What drives them? • inside information: yes • chat: no! (just the opposite)

20. 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)

21. Example for an asset bubble above 150 prices cannot be justified by any information on supplements back

22. 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

23. nice convergence to a priori fundamental value of 94... But didn‘t adjust expected value for other assets → market bubble (but no asset bubble) ... and 150. Information on supplement correctly revealed back

24. Bubble count • no indication that later rounds produce fewer bubbles

25. Probitrandom effects model # of subjects who believe that they are going to be top trader in treatment

26. 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

27. 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

28. 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?

29. Speculation or confusion? price at end of this day fundamental value

30. Speculation or confusion? In bubbles rounds: Big difference between expected price after this day and expected dividend → favors speculation hypothesis

31. Are prices fully revealing (REE)? Comparison of final prices to REE prices

32. Tactics of insiders • How do insiders trade? • want to profit from their info without giving it away • may try to mislead non-insiders

33. 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

34. The slow build-up Mean holdings of insider assets by insiders

35. Timing and prices of bids(by insiders for insider asset) in seconds

36. Frequency of bids other bids by insiders for insider asset in seconds

37. Conclusion • bubbles without dividends are possible • but additional factor necessary: • possibility that someone has inside information • chat: counterproductive?

38. Thank you for your attention

39. back

41. Solarworld Oil