Number Processing and Price Dynamics: A Market Experiment
45 Pages Posted: 27 Mar 2020
Date Written: January 31, 2020
Abstract
Conventional finance models assume that stock price magnitude should not influence portfolio choices or future returns. This view is contradicted, however, by empirical evidence. In this paper, we show that trading prices, in experimental markets, are processed differently by participants depending on their magnitude. Our experiment has two consecutive treatments. One where the fundamental value is a small number (small price market) and one where the fundamental value is a large number (large price market). Small price markets exhibit greater mispricing than large price markets. We obtain this result both between-participants and within-participants. Our findings indicate that price magnitude has a direct impact on how individuals perceive the distribution of future returns. This result is at odds with standard finance theory but is consistent with: (1) evidence in neuropsychology on the use of different mental scales for small and large numbers, and (2) empirical results in the finance and accounting literature.
Keywords: experimental markets, number perception, behavioral bias, stock price magnitude, mental scales
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