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Book part

Charles N. Noussair, Damjan Pfajfar and Janos Zsiros

We design experimental economies based on a New Keynesian Dynamic Stochastic General Equilibrium (DSGE) model. We apply shocks to tastes, productivity, and interest rate…

Abstract

We design experimental economies based on a New Keynesian Dynamic Stochastic General Equilibrium (DSGE) model. We apply shocks to tastes, productivity, and interest rate policy, and measure the persistence of these shocks. We find that, in a setting where goods are perfect substitutes, there is little persistence of output shocks compared to treatments with monopolistic competition, which perform similarly irrespective of whether or not menu costs are present. Discretionary central banking is associated with greater persistence than automated instrumental rules.

Details

Experiments in Macroeconomics
Type: Book
ISBN: 978-1-78441-195-4

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Article

Charles N. Noussair and Owen Powell

This paper aims to study how the trajectory of fundamental values affects price discovery in an experimental asset market.

Abstract

Purpose

This paper aims to study how the trajectory of fundamental values affects price discovery in an experimental asset market.

Design/methodology/approach

An experiment is conducted with two treatments, in which the time path of fundamentals differs between treatments. In the peak treatment, fundamentals first rise and then fall, while in the valley treatment fundamentals first fall and then recover. The experiment allows market prices to be compared to fundamental values.

Findings

Both peak and valley treatments experience bubbles when traders are inexperienced. However, price discovery is more rapid and complete in the peak than in the valley treatment. In the peak treatment, prices track the value, the direction of the trend, and changes in trend, more closely than in the valley treatment.

Originality/value

This paper documents the first experimental results regarding pricing behavior in markets with non‐monotonic fundamentals. It creates an environment (the valley treatment) in which convergence to close to fundamentals does not occur even with repetition of the market under identical conditions. The results demonstrate that the likelihood that an asset market tracks fundamentals depends on the time path of fundamentals.

Details

Journal of Economic Studies, vol. 37 no. 2
Type: Research Article
ISSN: 0144-3585

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Abstract

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Experiments in Macroeconomics
Type: Book
ISBN: 978-1-78441-195-4

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Book part

John Duffy

This article discusses the methodology of using laboratory methods to address macroeconomic questions. It also provides summaries of the articles in this volume.

Abstract

This article discusses the methodology of using laboratory methods to address macroeconomic questions. It also provides summaries of the articles in this volume.

Details

Experiments in Macroeconomics
Type: Book
ISBN: 978-1-78441-195-4

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Article

Luba Petersen

– The purpose of this paper is to explore the ability of monetary policy to generate real effects in laboratory general equilibrium production economies.

Abstract

Purpose

The purpose of this paper is to explore the ability of monetary policy to generate real effects in laboratory general equilibrium production economies.

Design/methodology/approach

To understand why monetary policy is not consistently effective at stabilizing economic activity, the author vary the types of agents interacting in the economy and consider treatments where subjects are playing the role of households (firms) in an economy where automated firms (households) are programmed to behave rationally.

Findings

While the majority of participants’ expectations respond to monetary policy in the direction intended, subjects do form expectations adaptively, relying heavily on past variables and forecasts in forming two-steps-ahead forecasts. Moreover, in the presence of counterparts that are boundedly rational, forecast accuracy worsens significantly. When interacting with automated households, updating firms’ prices respond modestly to monetary policy and significantly to anticipated marginal costs and future prices. The greatest deviations in behavior from theoretical predictions arise from human households (HH). Households persistent oversupply of labor and under-consumption is attributed to precautionary saving and debt aversion. The results provide evidence that the effects of monetary policy on decision making hinge on the distribution of indebtedness of households.

Originality/value

The author present causal evidence of the effects of potential bounded rationality on agents’ consumption and labor decisions.

Details

Journal of Economic Studies, vol. 42 no. 6
Type: Research Article
ISSN: 0144-3585

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Book part

Gregory S. Berns, C. Monica Capra, Sara Moore and Charles Noussair

Purpose – We summarize three previous neuroeconomic studies with two features that distinguish them from most others in experimental economics: (1) the use of physical…

Abstract

Purpose – We summarize three previous neuroeconomic studies with two features that distinguish them from most others in experimental economics: (1) the use of physical pain to induce incentives and (2) acquisition of data on brain activation levels. By correlating behavior when payoffs are painful with brain activation, we are able to test for the neurobiological relevance of important phenomena previously observed in experimental studies that are at odds with classical economic theories of decision-making. These specific phenomena are (a) negative discounting of future payoffs; (b) nonlinear probability weighting; (c) the experience of regret and rejoice when making a decision under risk.

Methodology/approach – The expectation of pain is created through the use of mild electric shocks to the top of the foot. Pain confers disutility, so decisions are made in the domain of losses relative to the status quo. Simultaneous with these decisions, brain activation data is acquired through functional magnetic resonance imaging (fMRI).

Findings – We find evidence for negative time discounting of electric shocks. Participants who exhibited the most extreme forms of this discounting were distinguished by early and robust activation of a subset of the cortical pain matrix. We also find evidence for probability weighting in the domain of electric shocks, which is manifest at the neural level. We find evidence both behaviorally and neurally for regret and rejoice functions for painful outcomes.

Originality/value of chapter – Previous experimental economic studies in the domain of losses have typically used monetary rewards. Here, we report behavioral effects and neural correlates using pain.

Details

Neuroeconomics
Type: Book
ISBN: 978-1-84855-304-0

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Article

Frank Heinemann and Charles Noussair

– The purpose of this paper is to introduce the upcoming symposium on experimental macroeconomics in the November issue.

Abstract

Purpose

The purpose of this paper is to introduce the upcoming symposium on experimental macroeconomics in the November issue.

Design/methodology/approach

Experimental, survey of articles in the symposium.

Findings

The paper describes how experiments can be used in macroeconomics.

Originality/value

The paper discusses the rationale for using behavioral experiments in macroeconomics, and summarizes the papers in the symposium.

Details

Journal of Economic Studies, vol. 42 no. 6
Type: Research Article
ISSN: 0144-3585

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Article

Martin Dufwenberg

How can laboratory experiments help us understand banking crises, including the usefulness of various policy responses? After giving a concise introduction to the field of…

Abstract

Purpose

How can laboratory experiments help us understand banking crises, including the usefulness of various policy responses? After giving a concise introduction to the field of experimental economics more generally, the author attempts to provide answers. The paper aims to discuss this issue.

Design/methodology/approach

The author discusses methodology and surveys relevant work.

Findings

History is often too complicated to be meaningfully revamped or modified in the lab, for purposes of insight-by-analogy. But as people argue about how to understand financial history, they bring ideas to the table. It is possible and useful to test the empirical relevance of these ideas in lab experiments.

Originality/value

The paper pioneers broad discussion of how lab experiments may shed light on banking crises.

Details

Journal of Economic Studies, vol. 42 no. 6
Type: Research Article
ISSN: 0144-3585

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Article

Charles Noussair and Yilong Xu

The purpose of this paper is to consider whether asymmetric information about correlations between assets can induce financial contagion. Contagion, unjustified by…

Abstract

Purpose

The purpose of this paper is to consider whether asymmetric information about correlations between assets can induce financial contagion. Contagion, unjustified by fundamentals, would arise if participants react in one market to uninformative trades in the other market that actually convey no relevant information. The authors also consider whether the market accurately disseminates insider information about fundamental value correlations when such information is indeed present.

Design/methodology/approach

The authors employ experimental asset markets to answer the research questions. The experimental markets allow participants to simultaneously trade two assets for multiple rounds. In each round, a shock occurs, which either have an idiosyncratic effect on the shocked asset, or a systematic effect on both assets. Half of the time, there exist insiders who know the true nature of the shock and how it affects the value of the other asset. The other half of the time, no agent knows whether there is a correlation between the assets. In such cases, there is the potential for the appearance of information mirages. Uninformed traders, in either condition, do not know whether or not there exist insiders, but can try to infer this from the market activity they observe.

Findings

The results of the experiment show that when inside information about the nature of the correlation between assets does exist, it is readily disseminated in the form of market prices. However, when there is no private information (PI), mirages are common, demonstrating that financial contagion can arise in the absence of any fundamental relationship between assets. An analysis of individual behavior suggests that some unprofitable decisions appear to be related to an aversion to complex distributions of lottery payoffs.

Originality/value

The study focusses on one of the triggers of unjustified financial contagion, namely, asymmetric information. The authors have studied financial contagion in a controlled experimental setting where the authors can carefully control information, and specify the fundamental interdependence between assets traded in different markets.

Details

Journal of Economic Studies, vol. 42 no. 6
Type: Research Article
ISSN: 0144-3585

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Article

Xiyang Li, Bin Li, Tarlok Singh and Kan Shi

This study aims to draw on a less explored predictor – the average correlation of pairwise returns on industry portfolios – to predict stock market returns (SMRs) in the USA.

Abstract

Purpose

This study aims to draw on a less explored predictor – the average correlation of pairwise returns on industry portfolios – to predict stock market returns (SMRs) in the USA.

Design/methodology/approach

This study uses the average correlation approach of Pollet and Wilson (2010) and predicts the SMRs in the USA. The model is estimated using monthly data for a long time horizon, from July 1963 to December 2018, for the portfolios comprising 48 Fama-French industries. The model is extended to examine the effects of a longer lag structure of one-month to four-month lags and to control for the effects of a number of variables – average variance (AV), cyclically adjusted price-to-earnings ratio (CAPE), term spread (TS), default spread (DS), risk-free rate returns (R_f) and lagged excess market returns (R_s).

Findings

The study finds that the two-month lagged average correlation of returns on individual industry portfolios, used individually and collectively with financial predictors and economic factors, predicts excess returns on the stock market in an effective manner.

Research limitations/implications

The methodology and results are of interest to academics as they could further explore the use of average correlation to improve the predictive powers of their models.

Practical implications

Market practitioners could include the average correlation in their asset pricing models to improve the predictions for the future trend in stock market returns. Investors could consider including average correlation in their forecasting models, along with the traditional financial ratios and economic indicators. They could adjust their expected returns to a lower level when the average correlation increases during a recession.

Social implications

The finding that recession periods have effects on the SMRs would be useful for the policymakers. The understanding of the co-movement of returns on industry portfolios during a recession would be useful for the formulation of policies aimed at ensuring the stability of the financial markets.

Originality/value

The study contributes to the literature on three counts. First, the study uses industry portfolio returns – as compared to individual stock returns used in Pollet and Wilson (2010) – in constructing average correlation. When stock market becomes more volatile on returns, the individual stocks are more diverse on their performance; the comovement between individual stock returns might be dominated by the idiosyncratic component, which may not have any implications for future SMRs. Using the industry portfolio returns can potentially reduce such an effect by a large extent, and thus, can provide more reliable estimates. Second, the effects of business cycles could be better identified in a long sample period and through several sub-sample tests. This study uses a data set, which spans the period from July 1963 to December 2018. This long sample period covers multiple phases of business cycles. The daily data are used to compute the monthly and equally-weighted average correlation of returns on 48 Fama-French industry portfolios. Third, previous studies have often ignored the use of investors’ sentiments in their prediction models, while investors’ irrational decisions could have an important impact on expected returns (Huang et al., 2015). This study extends the analysis and incorporates investors’ sentiments in the model.

Details

Accounting Research Journal, vol. 33 no. 2
Type: Research Article
ISSN: 1030-9616

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