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An Experimental Study of Bond Market Pricing

Bank of Lithuania Working Paper No 30/2016

51 Pages Posted: 9 Aug 2016 Last revised: 19 Jul 2017

Matthias Weber

Bank of Lithuania - Center for Excellence in Finance and Economic Research (CEFER); Vilnius University

John Duffy

University of California, Irvine

Arthur J. H. C. Schram

University of Amsterdam - Faculty of Economics and Business (FEB); Tinbergen Institute

Multiple version iconThere are 2 versions of this paper

Date Written: August 4, 2016

Abstract

The experimental literature on asset markets has provided many useful insights on the efficiency of market mechanisms. It is unclear whether these results carry over to bonds markets, however. An important feature of bond markets is the relationship between initial public offering (IPO) prices and the probability that the bond issuer will default. First, this probability affects the value of the bond and, therefore, the bond prices. Second, prices paid for the bonds in the IPO determine the bond issuer’s financing costs and, therefore, affect the probability that the bond issuer defaults. We develop a flexible bond market model that accounts for this two-way interaction and that is easily implemented in the laboratory. We examine how subjects price bonds in this setting and find that subjects learn to price bonds rather well after only a few repetitions (both during the IPO and while trading in the secondary market afterward). Bubbles in bond prices are only observed among inexperienced traders. The overall high degree of market efficiency that we find occurs in environments with both increasing and decreasing (equilibrium) fundamental values for bonds.

Keywords: bond markets, experimental finance, experimental markets, asset pricing, learning

JEL Classification: C92, C90, D47, G12

Suggested Citation

Weber, Matthias and Duffy, John and Schram, Arthur J. H. C., An Experimental Study of Bond Market Pricing (August 4, 2016). Bank of Lithuania Working Paper No 30/2016. Available at SSRN: https://ssrn.com/abstract=2818424 or http://dx.doi.org/10.2139/ssrn.2818424

Matthias Weber (Contact Author)

Bank of Lithuania - Center for Excellence in Finance and Economic Research (CEFER) ( email )

Totoriu g. 4
Vilnius, LT-01121
Lithuania

Vilnius University ( email )

Sauletekio ave. 11, Vilnius
Vilnius
Lithuania

John Duffy

University of California, Irvine ( email )

Department of Economics
3151 Social Science Plaza
Irvine, CA 92697
United States
949-824-8341 (Phone)

Arthur J. H. C. Schram

University of Amsterdam - Faculty of Economics and Business (FEB) ( email )

Roetersstraat 18
CREED
Amsterdam 1018 WB
Netherlands
+31 (0)20 525 4293 (Phone)

HOME PAGE: http://www.fee.uva.nl/creed/PEOPLE/Arthurs.htm

Tinbergen Institute ( email )

Burg. Oudlaan 50
Rotterdam, 3062 PA
Netherlands

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