Can humans avoid financial bubbles?

Here is how the standard economic experiment in trading works: A group of a dozen people are given money and shares to trade in isolation from behind a computer terminal. Each share pays some dividend, which averages 24 cents, paid at the end of a trading round (the actual dividend for different shares vary, just like real stocks). The fundamental value of each stock can be easily calculated by an Econ. Heck, by a Human too. It is just the expected value of a future dividend stream at any time. So if there are 15 trading rounds and the dividend is 24 cents, the expected value is 15*.24 or $3.60. This simple calculation ignores capital gain, which is unknown, and depreciation, which is zero in this case because all the rounds are finished in an afternoon. So do stock prices follow fundamental values? Of course not.

Again and again, in experiment after experiment, the trading price runs up way above fundamental value. Then, as the 15th round nears, it crashes. The problem doesn’t seem to be that participants are bored and fooling around. The difference between a good trading performance and a bad one is about $80 for a three-hour session, enough to motivate cash-strapped students to do their best. Besides, (Charles Noussair, a professor at Tilburg University) emphasizes, “you don’t just get random noise. You get bubbles and crashes.” Ninety percent of the time.

From the Atlantic.

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