Do Option-Like Incentives Induce Overvaluation? Evidence from Exerimental Asset Markets
37 Pages Posted: 23 Jan 2013
Date Written: January 23, 2013
One potential reason for bubbles evolving prior to the financial crisis was excessive risk taking stemming from option-like incentive schemes in financial institutions. By running laboratory asset markets, we investigate the impact of option-like incentives on price formation and trading behavior. We observe (i) that option-like incentives induce significantly higher market prices than linear incentives. We further find that (ii) option-like incentives provoke subjects to behave differently and to take more risk than subjects with linear incentives. We finally show that (iii) trading at inflated prices is rational for subjects with option-like incentives since it increases their expected payout.
Keywords: Mispricing, incentives, market efficiency, experimental finance
JEL Classification: C92, D84, G10
Suggested Citation: Suggested Citation