Price Discovery in Financial Markets: The Case of the CAPM

Social Science Working Paper No. 1032

45 Pages Posted: 7 Apr 2000

See all articles by Peter Bossaerts

Peter Bossaerts

University of Melbourne - Department of Finance

D. Kleiman

Lehman Brothers, New York

Charles R. Plott

California Institute of Technology - Division of the Humanities and Social Sciences

Date Written: Undated

Abstract

We report on experiments of simple, repeated asset markets in two risky securities and one risk-free security, set up to test the Capital Asset Pricing Model (CAPM), which embeds the two most essential principles of modern asset pricing theory, namely, (i) financial markets equilibrate, (ii) in equilibrium, risk premia are solely determined by covariance with aggregate risk. Slow, but steady convergence towards the CAPM is discovered. The convergence process, however, halts before reaching the actual equilibrium. There is ample evidence that subjects gradually move up in mean-variance space, in accordance with the CAPM. Yet, adjustment stops as if the remaining trading time was insufficient to complete all the transactions that are needed to guarantee improvements in positions. We conjecture that this is due to subjects' hesitance in the face of market thinness. Because the convergence process halts, statistical tests reject the CAPM.

Keywords: Capital Asset Pricing Model (CAPM), Experimental Economics, Financial Markets, Equilibrium, Equilibration.

JEL Classification: C92, D59, G12

Suggested Citation

Bossaerts, Peter L. and Kleiman, D. and Plott, Charles R., Price Discovery in Financial Markets: The Case of the CAPM (Undated). Social Science Working Paper No. 1032. Available at SSRN: https://ssrn.com/abstract=216820 or http://dx.doi.org/10.2139/ssrn.216820

Peter L. Bossaerts (Contact Author)

University of Melbourne - Department of Finance ( email )

Faculty of Economics and Commerce
Department of Finance
Carlton, Victoria 3010
Australia

HOME PAGE: http://bmmlab.org

D. Kleiman

Lehman Brothers, New York

745 Seventh Avenue
New York, NY 10019
United States

Charles R. Plott

California Institute of Technology - Division of the Humanities and Social Sciences ( email )

1200 East California Blvd.
337 Baxter Hall
Pasadena, CA 91125
United States
626-395-4209 (Phone)

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