Cognitive bubbles

• Published in: Experimental economics : a journal of the Economic Science Association Vol. 21; no. 1; pp. 132 - 153
• Main Authors: Bosch-Rosa, Ciril, Meissner, Thomas, Bosch-Domènech, Antoni
• Format: Journal Article
• Language: English
• Published: New York Springer US 01.03.2018; Springer Nature B.V
• Subjects: Assets; Behavioral/Experimental Economics; Bubbles; Cognition & reasoning; Economic theory; Economic Theory/Quantitative Economics/Mathematical Methods; Economics; Economics and Finance; Game Theory; Markets; Microeconomics; Operations Research/Decision Theory; Original Paper; Research subjects; Social and Behav. Sciences; Sophistication; D84; Bubbles; D12; G11; C91; Asset market experiment; Cognitive sophistication
• ISSN: 1386-4157; 1573-6938
• DOI: 10.1007/s10683-017-9529-0

Smith et al. (Econometrica 56(5):1119, 1988 ) reported large bubbles and crashes in experimental asset markets, a result that has been replicated many times. Here we test whether the occurrence of bubbles depends on the experimental subjects’ cognitive sophistication. In a two-part experiment, we first run a battery of tests to assess the subjects’ cognitive sophistication and classify them into low or high levels. We then invite them separately to two asset market experiments populated only by subjects with either low or high cognitive sophistication. We observe classic bubble and crash patterns in markets populated by subjects with low levels of cognitive sophistication. Yet, no bubbles or crashes are observed with our sophisticated subjects, indicating that cognitive sophistication of the experimental market participants has a strong impact on price efficiency.