Asset Price Volatility and Investment Horizons: An Experimental Investigation
65 Pages Posted: 5 Oct 2020
Date Written: August 17, 2020
We study the effects of the investment horizon on asset price volatility using a Learning to Forecast experiment. We end that, for short investment horizons, participants coordinate on self-fulfilling trend extrapolating predictions. Price deviations are then reinforced and amplified, possibly leading to large bubbles and crashes in asset prices. For longer investment horizons such bubbles do not emerge and price volatility tends to be lower. This is due to the fact that, for longer horizons, there is more dispersion in participants' forecasts, and participants extrapolate trends in past prices to a lesser extent. We also show that, independent of the investment horizon, if the initial history of asset prices is already relatively stable before participants start their prediction task, price volatility remains small, with prices close to their fundamental values for the duration of the experiment.
Keywords: Experimental Economics, Expectations, Asset Pricing, Investment Horizons, Behavioral Finance
JEL Classification: C91, G12, G14, G41
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