A Futures Market Reduces Bubbles But Allows Greater Profit for More Sophisticated Traders

CentER Discussion Paper Series No. 2014-051

36 Pages Posted: 2 Sep 2014

See all articles by Charles N. Noussair

Charles N. Noussair

Tilburg University

Steven James Tucker

University of Waikato Management School - Economics

YiLong Xu

Utrecht University, School of Economics (U.S.E.)

Date Written: September 2, 2014

Abstract

We study the effect of the addition of a futures market, in which contracts maturing in the last period of the life of the asset can be traded. Our experiment has two treatments, one in which a spot market operates on its own, and a second treatment in which a spot and futures market are active simultaneously. We find that the futures market reduces spot market mispricing among a trader population prone to bubbles, while having no effect on mispricing in a group not prone to it. Thus, overall, futures markets aid price discovery in the spot market, although the futures markets themselves exhibit considerable overpricing. Individuals with higher cognitive reflection test (CRT) scores achieve greater earnings, as they tend to sell in the overpriced futures market, while traders with lower CRT score make purchases in the futures market. We also consider the predictive power of an enhanced CRT measure (ECRT), which weights two types of incorrect answers differently.

Keywords: asset market experiment; market institution; futures market

JEL Classification: C91, G13

Suggested Citation

Noussair, Charles N. and Tucker, Steven James and Xu, YiLong, A Futures Market Reduces Bubbles But Allows Greater Profit for More Sophisticated Traders (September 2, 2014). CentER Discussion Paper Series No. 2014-051, Available at SSRN: https://ssrn.com/abstract=2490326 or http://dx.doi.org/10.2139/ssrn.2490326

Charles N. Noussair (Contact Author)

Tilburg University ( email )

P.O. Box 90153
Tilburg, DC Noord-Brabant 5000 LE
Netherlands

Steven James Tucker

University of Waikato Management School - Economics ( email )

Hamilton
New Zealand

YiLong Xu

Utrecht University, School of Economics (U.S.E.) ( email )

Kriekenpitplein 21-22
Adam Smith Building
Utrecht, +31 30 253 7373 3584 EC
Netherlands

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