Asset Price Volatility and Investment Horizons: An Experimental Investigation

Abstract

We study the effects of the investment horizon on asset price volatility using a Learning to Forecast experiment. We find 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.

The impact of interest rate policy on individual expectations and asset bubbles in experimental markets

“…Their findings seem to be in the opposite direction to Fischbacher et al (2013) and Giusti et al (2016): while leverage constraints are ineffective at stabilizing asset prices, a "leaning against the wind' policy reduces price deviation and market volatility. A main difference between our study and these previous studies is that while they adopt a learning-tooptimize experiment (LtOE, Duffy, 2010, 2016 design in which subjects trade the assets directly, we employ a learning-to-forecast experiment (LtFE, Marimon et al, 1993, Marimon and Sunder, 1994, Hommes et al, 2005, 2008, Hommes, 2011, Heemeijier et al, 2009, Bao et al, 2012, 2016, Anufriev et al, 2018, Arifovic and Duffy, 2018 design in which the subjects submit only a price forecast and their trading quantity and the asset prices are calculated automatically by a computer program. These features of LtFEs allow us to focus on subjects' bounded rationality or deviation from the rational expectation hypothesis in expectation formation only and to rule out the influence of other factors, such as failure to calculate the optimal quantity decision for a given price expectation.…”