Speculation and Price Indeterminacy in Financial Markets: An Experimental Study

Abstract

To explore how speculative trading influences prices in financial markets we conduct a laboratory market experiment with speculating investors (who do not collect dividends and trade only for capital gains) as well as dividend-collecting investors. We find that in markets with only speculating investors (i) price deviations from fundamentals are larger; (ii) prices are more volatile; (iii) the “mispricing” is likely to be strategic and not irrational; (iv) mispricing increases with the number of transfers until maturity; and (v) speculative trading pushes prices upward (downward) when liquidity is high (low).

Keywords: Experimental finance, Speculation, Rational expectations, Price efficiency, Price bubbles, Overlapping generations, Backward and forward induction

JEL Classification: C91, G11, G12