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Basic Principles of Asset Pricing Theory: Evidence from Large-scale Experimental Financial Markets

Bossaerts, Peter and Plott, Charles (2004) Basic Principles of Asset Pricing Theory: Evidence from Large-scale Experimental Financial Markets. Review of Finance, 8 (2). pp. 135-169. ISSN 1572-3097. doi:10.1023/B:EUFI.0000035190.24818.e5.

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We report on two sets of large-scale financial markets experiments that were designed to test the central proposition of modern asset pricing theory, namely, that risk premia are solely determined by covariance with aggregate risk. We analyze the pricing within the framework suggested by two theoretical models, namely, the (general) Arrow and Debreu's complete-markets model, and the (more specific) Sharpe-Lintner-Mossin Capital Asset Pricing Model (CAPM). Completeness of the asset payoff structure justifies the former; the small (albeit non-negligible) risks justifies the latter. We observe swift convergence towards price patterns predicted in the Arrow and Debreu and CAPM models. This observation is significant, because subjects always lack the information to deliberately set asset prices using either model. In the first set of experiments, however, equilibration is not always robust, with markets temporarily veering away. We conjecture that this reflects our failure to control subject' beliefs about the temporal independence of the payouts. Confirming this conjecture, the anomaly disappears in a second set of experiments, where states were drawn without replacement. We formally test whether CAPM and Arrow–Debreu equilibrium can be used to predict price movements in our experiments and confirm the hypothesis. When multiplying the subject payout tenfold (in real terms), to US $ 500 on average for a 3-h experiment, the results are unaltered, except for an increase in the recorded risk premia.

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URLURL TypeDescription ItemSSWP 1070
Bossaerts, Peter0000-0003-2308-2603
Additional Information:© 2004 Kluwer Academic Publishers. Awarded the 2004 GSAM Quant Best Paper Prize and the GAIM Research Paper of the Year 2006 Award. Financial support was provided by the Caltech Laboratory of Experimental Economics and Political Science, the National Science Foundation, the International Center For Finance at Yale University and a grant from the Jenkins Family Foundation to Caltech. We thank Bill Brown (Claremont), Peter DeMarzo (Berkeley, now at Stanford), Will Goetzmann (Yale), Mark Johnson (Tulane), Tony Kwasnica (Penn State), Claude Montmarquette and Claudia Keser (CIRANO, Montréal), William Sharpe (Stanford), Woody Studenmund (Occidental College), and Ivo Welch (UCLA, now at Yale), for allowing us to involve their students in our experimental financial markets. Elena Asparouhova (now at Utah) facilitated the Bulgarian experiment. The paper benefited from comments at many seminars and meetings throughout the world. Constructive criticism from the editor and two referees is gratefully accepted, but only the authors are responsible for remaining errors. Formerly SSWP 1070.
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Caltech Laboratory for Experimental Economics and Political ScienceUNSPECIFIED
Yale University International Center For FinanceUNSPECIFIED
Jenkins Family FoundationUNSPECIFIED
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Social Science Working Paper1070
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Record Number:CaltechAUTHORS:20140317-153601944
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Usage Policy:No commercial reproduction, distribution, display or performance rights in this work are provided.
ID Code:44372
Deposited On:18 Mar 2014 15:45
Last Modified:10 Nov 2021 16:51

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