Bid-ask spreads in multiple dealer settings: Some experimental evidence

We report the results of an experiment designed to investigate the behavior of quoted spreads in multiple-dealer markets. We manipulate verbal communication (not allowed and allowed) and order preferencing (not allowed, allowed, and allowed with order-flow payment) between eighteen sessions. Without preferencing, spreads are wider when communication is allowed. With preferencing (and no order-flow payments), individuals do not have incentives to narrow the spread and a wide spread may be maintained without a collusive agreement. However, spreads narrow somewhat when individuals are given the opportunity to compete using alternatives to price (that is, payment for order flow).Financial markets

The Distribution of X-ray Dips with Orbital Phase in Cygnus X-1

We present results of a comprehensive study of the distribution of absorption dips with orbital phase in Cygnus X-1. Firstly, the distribution was obtained using archival data from all major X-ray observatories and corrected for the selection effect that phase zero (superior conjunction of the black hole) has been preferentially observed. Dip occurrence was seen to vary strongly with orbital phase \phi, with a peak at \phi ~ 0.95, i.e. was not symmetric about phase zero. Secondly, the RXTE ASM has provided continuous coverage of the Low State of Cygnus X-1 since Sept. 1996, and we have selected dip data based on increases in hardness ratio. The distribution, with much increased numbers of dip events, confirms that the peak is at \phi ~ 0.95, and we report the discovery of a second peak at \phi ~ 0.6. We attribute this peak to absorption in an accretion stream from the companion star HDE 226868. We have estimated the ionization parameter at different positions showing that radiative acceleration of the wind is suppressed by photoionization in particular regions in the binary system. To obtain the variation of column density with phase, we make estimates of neutral wind density for the extreme cases that acceleration of the wind is totally suppressed, or not suppressed at all. An accurate description will lie between these extremes. In each case, a strong variation of column density with orbital phase resulted, similar to the variation of dip occurrence. This provides evidence that formation of the blobs in the wind which lead to absorption dips depends on the density of the neutral component in the wind, suggesting possible mechanisms for blob growth.Comment: 9 pages, Latex, 7 ps figures. accepted by MNRA

The effects of subject pool and design experience on rationality in experimental asset markets

Empirical evidence suggests that prices do not always reflect fundamental values and individual behavior is often inconsistent with rational expectations theory. We report the results of fourteen experimental markets designed to examine whether the interactive effect of subject pool and design experience tempers price bubbles and improves forecasting ability. Our main findings are: (i) price run-ups are modest and dissipate quickly when traders are knowledgeable about financial markets and have design experience; (ii) price bubbles moderate quickly when only a subset of traders are knowledgeable and experienced; and (iii) individual forecasts of price are not consistent with the predictions of the rational expectations model in any market.Financial markets

The effect of forecast bias on market behavior: evidence from experimental asset markets

This paper reports the results of 15 experimental asset markets designed to investigate the effect of optimistic forecast bias on market behavior. Each market is organized as a double oral auction in which participants trade a single-period asset with uncertain value. Traders are informed of the asset value distribution and, prior to trading, given the opportunity to acquire a forecast of the asset's period-end value. The degree of forecast bias is manipulated across experimental sessions so that in some sessions the forecast contains a systematic, upward (low or high) bias. We conduct sessions with inexperienced and experienced traders. The results suggest that market prices are supportive of a full revelation unbiased price in the unbiased markets and the experienced, low-bias markets. The results from the low-bias markets indicate that as long as traders have sufficient experience with such forecasts, asset prices reflect the debiased forecasts. In contrast, we find no evidence that high-bias forecasts are reflected in market prices, regardless of experience. We also find that the demand for forecasted information persists over time, but it is greater in the unbiased and low-bias conditions than in the high-bias condition. Finally, we provide little evidence that the net profit (that is, net of the information cost) of informed and uninformed traders differs, regardless of bias condition or experience level.Forecasting ; Asset pricing

Uncertain litigation cost and seller behavior: Evidence from an auditing game

This paper reports the results of two experiments, each consisting of six sessions, designed to investigate difficulties that arise in estimating expected litigation costs in an auditing game. In each experimental session, the game consists of a series of periods in which sellers submit sealed offers to computerized buyers and, if hired, choose an effort level (low or high). The effort level affects the certain (direct) and uncertain (litigation) costs of performing the engagement. Across the two experiments, we vary the uncertainty surrounding the determination of the expected litigation cost. Our results strongly suggest that cognitive limitations hinder sellers' abilities to estimate total expected litigation costs. Across both experiments we observe a nontrivial number of suboptimal effort choices. Moreover, as the uncertainty of determining the expected litigation cost increases, the frequency of observed fee offers below the total expected cost of an engagement increases markedly.Accounting

Social Distance and Reciprocity

Contrary to the predictions of non-cooperative game theory, trust and reciprocity are commonly reported in simple games. We conduct a one-shot investment game to examine how social distance affects behavior in two-person exchanges. Two aspects of social distance are examined: ex post revelation of complete information on the second playerâ??s choice set and ex post revelation of information regarding the second playerâ??s identity. The results indicate that reciprocity is not affected by knowledge of the choice set, but depends critically on the possible revelation of the decision makerâ??s identity. That is, the possibility that the second playerâ??s identity (picture) is revealed to his/her counterpart has a profound effect on the degree of reciprocity extended.

Asset prices and informed traders' abilities: evidence from experimental asset markets

This study reports the results of fifteen experimental asset markets designed to investigate the effects of forecasts on market prices, traders' abilities to assess asset value, and the link between the two. Across the fifteen markets, the authors investigate alternative forecast-generating processes. In some markets the process produces an unbiased estimate of asset value and in others a biased estimate. The processes generating the biased forecasts, though, are less variable than the process generating the unbiased forecast. The authors find that, in general, period-end asset price reflects private forecasts, regardless of the forecast-generating process. Subsequently, they investigate whether traders' abilities to use forecasts differ across the forecast-generating processes. The authors find that most are able to properly use unbiased forecasts. They refer to them as smart traders. By comparison, a significant proportion is unable to properly use biased forecasts (typically traders' adjustments for bias are insufficient). Linking market outcomes and traders' abilities, the authors find that asset price appears to properly reflect unbiased forecasts as long as the market includes at least two smart informed traders who have sufficient ability to influence market outcomes. To obtain a comparable result in markets with the biased forecast, at least three smart informed traders with sufficient ability to influence market outcomes are necessary.Forecasting ; Markets ; Financial markets ; Risk

An experimental study of circuit breakers: the effects of mandated market closures and temporary halts on market behavior

This paper analyzes the effect of circuit breakers on price behavior, trading volume, and profit-making ability in a market setting. We conduct nine experimental asset markets to compare behavior across three regulatory regimes: market closure, temporary halt, and no interruption. The presence of a circuit breaker rule does not affect the magnitude of the absolute deviation in price from fundamental value or trading profit. The primary driver of behavior is information asymmetry in the market. By comparison, trading activity is significantly affected by the presence of a circuit breaker. Mandated market closures cause market participants to advance trades.Financial markets ; Flow of funds ; Stock market

Bubbles in experimental asset markets: Irrational exuberance no more

The robustness of bubbles and crashes in markets for finitely lived assets is perplexing. This paper reports the results of experimental asset markets in which participants trade two assets. In some markets, price bubbles form. In these markets, traders will pay even higher prices for the asset with lottery characteristics, i.e., a claim on a large, unlikely payoff. However, institutional design has a significant impact on deviations in prices from fundamental values, particularly for an asset with lottery characteristics. Price run-ups and crashes are moderated when traders finance purchases of the assets themselves and are allowed to short sell.Financial markets ; Risk

Circuit breakers with uncertainty about the presence of informed agents: I know what you know . . . I think

This study conducts experimental asset markets to examine the effects of circuit breaker rules on market behavior when agents are uncertain about the presence of private information. Our results unequivocally indicate that circuit breakers fail to temper unwarranted price movements in periods without private information. Agents appear to mistakenly infer that others possess private information, causing price to move away from fundamental value. Allocative efficiencies in our markets are high across all regimes. Circuit breakers perform no useful function in our experimental asset markets.Markets ; Financial markets ; Risk