Retrading, production, and asset market performance

Abstract

Prior studies have shown that traders quickly converge to the price-quantity equilibrium in markets for goods that are immediately consumed, but they produce speculative price bubbles in resalable asset markets. We present a stock-flow model of durable assets in which the existing stock of assets is subject to depreciation and producers may produce additional units of the asset. In our laboratory experiments inexperienced consumers who can resell their units disregard the consumption value of the assets and compete vigorously with producers, depressing prices and production. Consumers who have first participated in experiments without resale learn to heed their consumption values and, when they are given the option to resell, trade at equilibrium prices. Reproducibility is therefore the most natural and most effective treatment for suppression of bubbles in asset market experiments.durable assets | stock-flow markets | specialization of trade | asset market bubbles C ontrary to rational theory the first asset market experiments with complete common information on fundamental value exhibited unexpectedly strong tendencies to yield price bubbles (1). The results, however, were soon extended (2, 3), independently replicated (4-8), and have quite important consequences for improved understanding of the sources of instability in the economy (9-11).In contrast with these robust asset market findings, earlier experiments had established that repeated trade across time periods in static supply and demand experiments yielded efficient rapid convergence to rational competitive equilibrium outcomes under strictly private decentralized information (12). In the supply and demand experiments, however, trades were for immediate consumption, as with hamburgers and haircuts; as noted in ref. 13, items could not be retraded and individuals knew in advance that they were specialized as buyers or sellers and could not switch roles depending on price as in asset markets.[These features also characterize nondurable goods and services in the US national accounts and represent approximately 75% of private product. Instability in the US national accounts arises from the remaining 25% (11)].Motivated by the glaring contrast in these two kinds of markets, Dickhaut et al. (13) reformulated the traditional supply and demand environment by explicitly modeling two goods: "cash" as a means of payment and a "commodity" that had a heterogeneous end-of-period "dividend" consumption yield value. This formulation exactly parallels the asset trading environment, except that cash and commodity endowments have only a oneperiod life and dividends are not common. Individual subjects received diverse endowments, but in each of 10 periods a subject was endowed with the same amounts of cash and commodity, thus inducing pure static supply and demand conditions across 10 periods. This reformulated framework allowed the study of convergence in a 2 × 2 design, (retrade, no retrade) × (low cash, high cash). Convergence was markedly slower in retrade vs. no retr...

Rediscovering Classical Economics in the Laboratory

“…In practice, expected prices are extrapolative (for example, based on past price changes that are trend-following), thus creating a destabilizing feedback loop 9 and a bubble that can keep on growing as long as it is backed by some source of liquidity, such as bank credit. The dichotomy between perishable and re-tradable goods and its relevance for macroeconomics have also been established experimentally (Smith, Suchanek, and Williams, 1988;Smith, 1994, 2003;Dickhaut, Lin, Porter, and Smith, 2012;Palan, 2013;Gjerstad and Smith, 2014;Gjerstad, Porter, Smith, and Winn, 2015;Smith and Inoua (2019). This explanation of economic crises and depressions as debt-fueled speculative bubbles coming to an end also goes back to the classical economists.…”

An Experimental Comparison of Two Exchange Economies: Long-Lived Asset vs. Short-Lived Asset

“…buy and sell, that is, they retrade claims of assets within the same period. Related literature suggests that retrading of assets would be a symptom of speculation (Lei et al 2001, Dickhaut et al 2012, and Gjerstad et al 2015, and Hirota et al (2018) report that mispricing increases with the required number of retrades across periods. In our experiment, the transaction volume is related to retrading behaviour.…”