Digital options and efficiency in experimental asset markets

• Published in: Journal of economic behavior & organization Vol. 75; no. 3; pp. 506 - 522
• Main Author: Palan, Stefan
• Format: Journal Article
• Language: English
• Published: Amsterdam Elsevier B.V 01.09.2010; Elsevier; Elsevier Sequoia S.A
• Series: Journal of Economic Behavior & Organization
• Subjects: Asset market; Asset market Digital option Experimental economics Bubble Efficiency; Asset pricing; Assets; Bubble; Capital market theory; Derivatives; Digital option; Discovery; Economic theory; Efficiency; Experimental economics; Experimentelle Ökonomik; Financial engineering; Finanzmarkt; Investment policy; Laboratories; Markets; Option pricing; Portfolio management; Price cuts; Prices; Quantitative Finance; Resource allocation; Spekulationsblase; Stock prices; Studies; Experimental economics; Bubble; D01; Efficiency; D02; G01; Digital option; Asset market; digital option; efficiency; experimental economics; bubble
• ISSN: 0167-2681; 1879-1751; 0167-2681
• DOI: 10.1016/j.jebo.2010.05.011

In asset markets, extraordinary price run-ups (bubbles) followed by crashes back to levels closer to fundamental values have been shown to adversely affect the real economy, leading to inefficient resource allocation and underinvestment. Conversely, derivative markets contribute to price discovery and lead to informationally more efficient prices in the market for the underlying asset. We combine these observations and test experimentally whether digital options – a type of derivative that has recently been introduced to a wider audience via online prediction markets – can reduce price bubbles in a laboratory setting. We find that subjects do not use the derivative market to improve their expectations of future asset prices and analyze this result.