Pairing Multi-Market Theory with Experiments

Abstract

Experiments constitute an indispensable tool to validate the building blocks of the theories which economists use not only to interpret events in the real world but also to inform regulation and economic policy. This is especially true in the context of multiple, interacting markets, which is the domain of most of asset pricing theory. We illustrate how theory and experiment interact using the example of lending when borrowers are better informed than lenders about the quality of their projects. We show how experiments identify the boundaries of inference from field (archival) data, in particular when such inference is aimed at informing regulation. We also discuss how experiments can become invaluable pedagogical tools in teaching. Good experimental design brings to life the – often abstract – assumptions behind the theory, and students’ cognitive and emotional engagement in the virtual world of the experiment facilitates comprehension and retention.

Keywords: asset pricing, general equilibrium, laboratory experiment, markets, Pareto efficiency, classroom experiment

JEL Classification: C90, D53, G11, G12