Essays on Trading Behavior in Financial Markets and Economic Growth
Abstract
This thesis includes three essays that examine issues on two different topics: (1) trading behavior in financial markets, and (2) economic growth. In Essay 1, we report the results of an experiment designed to study the role of speculation in the formation of bubbles and crashes in laboratory asset markets. In a setting in which speculation is not allowed, the bubble-crash phenomenon as well as systematic errors in decision making are observed. These results suggest that bubbles are caused by behavior that itself exhibits elements of irrationality. In markets where speculation is possible, much of the trading activity that accompanies bubble formation is due to the fact that there is no other activity available for participants in the experiment. In Essay 2, we assume that overconfident traders update their beliefs about the precision of their information in a biased way, and show how this cognitive error affects their trading behavior and their performance relative to benchmark traders in the long run. Traders' ability to interpret their private information is differentiated from information's precision itself. Our model shows that an overconfident trader tends to overreact to his failures but underreact to his successes. This could then cause him to trade less aggressively and underperform his rational opponent in the long run. Finally, in Essay 3, an experimental economy is designed to test the optimal growth model of Ramsey-Cass-Koopmans. The model predicts that the levels of consumption and capital stock converge to an optimal steady state level, regardless of the level of initial endowment. The main question considered in this study is whether such convergence can be observed in the experimental economy. There are two sets of parameters used in the experiment, Low Endowment and High Endowment, in which the initial level of capital stock is less than and greater than the optimal steady state level, respectively. In a decentralized implementation of the model with multiple agents and a market for capital, the variables in the economy have a strong tendency to converge to the optimal steady state levels in both Low and High Endowment cases. In contrast, when individual subjects are placed in the role of social planners, the economy is less likely to converge to its optimal steady state. These findings highlight the role of market institutions in enabling the economy to operate at its optimum.
Degree
Ph.D.
Advisors
Noussair, Purdue University.
Subject Area
Economics|Design
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