Financial Bubbles: Excess Cash, Momentum, and Incomplete Information

Caginalp, Gunduz; Porter, David; Smith, Vernon L.

doi:10.1207/s15327760jpfm0202_03

Cited by 174 publications

(109 citation statements)

References 13 publications

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“…These models incorporated the conservation of cash and asset, and made the predictions that (i) a larger cash supply would result in a larger bubble; (ii) a lower initial price would yield a larger bubble, both contrary to the expectations of EMH. Both of these predictions were confirmed by experiment (Caginalp, Porter and Smith [2001]). These experiments also demonstrated a role, though limited, for the open book, whereby all traders can see the full set of orders, in mitigating the size of the bubble.…”

Section: E-mail Addresses: Caginalp+@pittedu (G Caginalp) Vilieva@supporting

confidence: 65%

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The dynamics of trader motivations in asset bubbles

Caginalp

Ilieva²

2008

Journal of Economic Behavior & Organization

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Asset market experiments are analyzed by distinguishing, ex post facto, participants who trade on fundamentals versus those who trade on momentum (i.e., buying when price is rising). The distinction is made when prices are above fundamental value, so that (in each period) those who have more offers than bids (net offerers) are classified as fundamentalists while those who have more bids than offers (net bidders) are defined to be momentum players. By analyzing the data of individual behavior we are able to address a number of key questions regarding bubbles. We find evidence that the cash supply of the momentum traders diminishes and the cash supply of the fundamental traders increases as the bubble forms. This suggests that the bubble is fueled by the cash of the momentum players and the reversal is caused by inadequate cash in their possession. These data are used in conjunction with a difference equation for price dynamics for two groups. The momentum traders exhibit a positive coefficient for price derivatives and a very small negative coefficient for trading based upon the deviation from fundamental value. Surprisingly, however, the fundamental traders, who exhibit a positive coefficient for trading on valuation, also exhibit a significantly positive coefficient for trend based buying. Thus, even those who are net offerers, classified as fundamentalists, are selling less and buying more of overvalued stock when there is a strong positive recent price change. There is also evidence that some fundamentalists change strategy to momentum trading as prices soar. An additional result is that the trend coefficient of the momentum traders vanishes with the implementation of an "open book" that allows traders to see all trades as they are entered.JEL classification: G 120; C 900

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Section: E-mail Addresses: Caginalp+@pittedu (G Caginalp) Vilieva@supporting

confidence: 65%

“…In an earlier paper Caginalp, Porter and Smith [2001] show that the level of cash in an experimental economy is highly correlated with the size of a bubble for both the openbook and closed-book experiments. Taking this one step further we suggest that it is the bidding of the momentum traders that fuels the bubble.…”

Section: Resultsmentioning

confidence: 97%

The dynamics of trader motivations in asset bubbles

Caginalp

Ilieva²

2008

Journal of Economic Behavior & Organization

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“…For the regression analysis below, in addition to the 28 experiment sessions described above, we use the results from 53 previous 15-period asset market experiments with inexperienced, once-experienced and twice-experienced subjects in the baseline environment (the data come from SSW, Caginalp et al [2000], King et al [1993], Van Boening et al [1993] and Caginalp et al [2001]). Across all the data, if experience is robust we should find that the characteristics of the rekindle treatment should be equivalent to the twice-experienced treatments and bubbling should diminish with experience in the new replication treatments.…”

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confidence: 99%

Thar She Blows: Can Bubbles Be Rekindled with Experienced Subjects?

Hussam

Porter

Smith

2008

American Economic Review

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We report 28 new experiment sessions consisting of up to three experience levels to examine the robustness of learning and 'error' elimination by participants in a laboratory asset market and its effect on price bubbles. Our answer to the title question is: "yes."We impose a large increase in liquidity and dividend uncertainty to shock the environment of experienced subjects who have converged to equilibrium, and this treatment rekindles a bubble. However, in replications of that challenging environment across three experience levels we discover that the environment yields a rare residual tendency to bubble even in the third experience session. Therefore, a caveat must be placed on the effect of twice experienced subjects in asset markets: in order for price bubbles to be extinguished, the environment in which the participants engage in exchange must be stationary and bounded by a range of parameters. Experience, including possible 'error' elimination, is not robust to major new environment changes in determining the characteristics of a price bubble.

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“…The 'Feedback theory' proposed by Shiller [28] or the 'Momentum strategy' proposed by Caginalp, Porter and Smith [6] can be best used to explain the psychological aspect of investors. If a particular stock was believed to be undervalued, it would encourage investors to buy out of value-based sentiment and thus generate an upward trend.…”

Section: Explanation Of Behavioral Finance Behind Bubble Burstmentioning

confidence: 99%

Stock Market Crash in Bangladesh: The Moneymaking Psychology of Domestic Investors

Rahman¹,

Hossain²,

Habibullah³

2017

AJTAB

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Abstract:After the cruel crash in 1996 Bangladesh stock market had started growing from 2006 due to listing of a few profitable government entities and Multinational Companies (MNCs). Together with individual investors nearly all commercial banks involved themselves intensely in stock market.Step by step, the bullish market transformed into a bubble and on December 05, 2010, the Dhaka Stock Exchange General Index (DGEN) reached at the record high of 8918.5, almost 5.6 times higher than December 2006. Concurrently, market capitalization and turnover increased by 11.1 times and 61.7 times respectively. However, when the bubble burst on December 19, 2010 the DGEN witnessed its biggest one day fall of 6.7 percent and since then the market has become bearish with almost no positive movement of stock prices. Against this backdrop, this study identified four moneymaking psychologies of domestic investors specifically greed, envy, speculation, and overconfidence that contributed to the formation of bubble, while four loss-minimizing and capital-protecting psychologies such as panic, frustration, lack of self-confidence, and distrust caused the bubble to burst. The bankers, brokers and manipulators were the biggest gainers, whereas the most unaware and greedy small investors encountered heavy loss. The market will be less volatile, more mature, and sustainable when most of the investors will be conscious about the potential risks and returns and the regulators will play their part sincerely and efficiently.

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Financial Bubbles: Excess Cash, Momentum, and Incomplete Information

Cited by 174 publications

References 13 publications

The dynamics of trader motivations in asset bubbles

The dynamics of trader motivations in asset bubbles

Thar She Blows: Can Bubbles Be Rekindled with Experienced Subjects?

Stock Market Crash in Bangladesh: The Moneymaking Psychology of Domestic Investors

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