Question 1

Consider a share with a declining fundamental value that trades for 10 periods. Which of the following phenomena would be most consistent with prices tracking fundamental value?

Accepted Answer

If the fundamental value of a share is declining, the most consistent scenario with prices tracking fundamental value would be for the average market price to peak as early as possible, which would be in Round 1, before the decline starts to be reflected in the prices.

Question 2

Suppose the dividend paid on a share takes one of four values, each with equal probability: $0.00, $0.08, $0.28 and $0.60. The share trades for 15 periods. The prevailing market interest rate is 10%. If you wanted to implement a flat fundament value for this share then you should set that fundamental value equal to:

Accepted Answer

The expected dividend per period is the average of the possible dividends: (0 + 0.08 + 0.28 + 0.60) / 4 = 0.24. The fundamental value is the present value of these expected dividends over 15 periods at a 10% interest rate. The formula for the present value of an annuity is used: PV = D * [(1 - (1 + r)^-n) / r], where D is the expected dividend, r is the interest rate, and n is the number of periods. Plugging in the values: PV = 0.24 * [(1 - (1 + 0.10)^-15) / 0.10] ≈ $2.40.

Question 3

Suppose a share has the flat fundamental value of $3.60. The share trades for 15 periods. The market interest rate is 10%. This implies that the per period expected dividend on the share must be:

Accepted Answer

The fundamental value of a share is the present value of its expected future dividends. Given a flat fundamental value of $3.60 and a market interest rate of 10%, the expected dividend per period must be such that the present value of these dividends equals $3.60. The expected dividend per period is $0.36, as $0.36 / 0.10 = $3.60.

Question 4

Suppose the dividend paid on a share takes one of four values, each with equal probability: $0.00, $0.08, $0.28 and $0.60. The share trades for 15 periods. You have chosen to implement a flat fundamental value of $4.80 for this share. This means that you must set the interest rate on cash holdings at:

Accepted Answer

The expected dividend per period is calculated as the average of the possible dividends: (0.00 + 0.08 + 0.28 + 0.60) / 4 = 0.24. To maintain a flat fundamental value of $4.80, the expected return (dividend yield) must equal the interest rate. Thus, 0.24 / 4.80 = 0.05, or 5%.

Question 5

Suppose you want to implement a market for a share with a flat fundamental value (P). Denote by E the per period expected dividend for this share and by R the market interest rate. Which of the following formula represents the correct expression for the flat fundamental value in this case?

Accepted Answer

The correct expression for the flat fundamental value of a share, given a constant expected dividend (E) and a market interest rate (R), is P = E/R. This formula is derived from the dividend discount model for a perpetuity, where the value of the share is the present value of all future dividend payments, assuming those payments are constant over time and the market interest rate remains the same.

Question 6

Which of the following is not a likely explanation for the bubble and crash pattern frequently seen in markets for financial assets?

Accepted Answer

The bubble and crash pattern in financial markets is often attributed to speculative behavior, trend-following, and doubts about others' rationality, rather than traders having rational expectations. Rational expectations theory suggests that individuals make decisions based on all available information and a rational understanding of the market, which would theoretically prevent bubbles and crashes caused by irrational speculation or herd behavior.

Question 7

Lei, Noussair and Plott's "excess trading" hypothesis regarding trading in financial asset markets relates to which of the following?

Accepted Answer

The "excess trading" hypothesis by Lei, Noussair, and Plott suggests that traders engage in high volumes of trading not necessarily because of market signals or rational investment strategies, but due to a lack of alternative activities to occupy their time during the experiment.

Question 8

Which of the following is an accurate description of the "no speculation" asset market set up in the study by Lei, Noussair and Plott.

Accepted Answer

The "no speculation" asset market setup by Lei, Noussair, and Plott is characterized by the restriction that buyers can only buy shares and cannot resell them, and sellers can only sell shares but cannot buy or rebuy shares. This setup is designed to eliminate speculative trading by restricting participants to a single role, either buying or selling, without the ability to reverse their position.

Question 9

In their 1988 study Smith et al. reported that asset prices lie above forecast prices during booms and below forecast prices during the slump. In their work, Haruvy, Lahav and Noussair suggest that this may be possibly due to the fact:

Accepted Answer

Haruvy, Lahav, and Noussair suggest that traders consider past market behaviors, which often show larger bubbles, influencing their forecasts and contributing to the observed price discrepancies.

Question 10

In the Haruvy, Lahav and Noussair study, the participants are asked to enter their prediction for the assets' market price for all remaining periods rather than just for the upcoming period. It is likely that doing so would:

Accepted Answer

Asking participants to predict the market price for all remaining periods encourages them to consider the end state and work their way backward to the present, aligning with the concept of backward induction. This approach alters their frame of reference by making them think about the long-term implications of their decisions.

Question 11

In the Haruvy, Lahav and Noussair study, the participants are asked to enter their prediction for the assets' market price for all remaining periods rather than just for the upcoming period. The authors find that when they do this with participants taking part in a series of markets lasting 15 periods each:

Accepted Answer

The study found that when participants predict prices for all remaining periods, the peak average market price occurs earlier in later markets, aligning more closely with the fundamental value of the asset.

Question 12

Martin Kocher and his colleagues find that groups consisting of a mixture of depleted and non-depleted self-control traders behave similar to groups of depleted self-control traders in terms of the pattern of bubbles and crashes. What do Kocher et al. suggest as a reason for this similarity in behaviour?

Accepted Answer

The answer of Martin Kocher and his colleagues find that...

Question 13

The familiar pattern of bubbles and crashes in markets for financial assets can be caused by a number of factors including (1) chasing speculative gains and (2) lack of common knowledge of the rationality of traders. Briefly explain what is meant by these two concepts.

Accepted Answer

The answer of The familiar pattern of bubbles and crashes...

Question 14

Why might a researcher wish to study an asset with a flat fundamental value? Assuming a redemption value of P, a per period expected dividend of E, and a market interest rate of R, explain how you would set the redemption value of this asset at the end of the trading period to generate a flat fundamental value.

Accepted Answer

The answer of Why might a researcher wish to study...

Question 15

Lei, Noussair and Plott argue that the familiar bubble and crash pattern observed in markets for financial assets may be caused by "excess trading" on the part of traders in the context of lab experiments. What do the authors mean by "excess trading"? How do they test this hypothesis by setting up a second market and what are the characteristics of that market?

Accepted Answer

The answer of Lei, Noussair and Plott argue that the...

Question 16

Why do Haruvy, Lahav and Noussair ask their participants to make predictions for asset prices not only for the next period but for all remaining periods? What is the implication for making these forecasts for future periods on the incidence of price peaks in those markets?

Accepted Answer

The answer of Why do Haruvy, Lahav and Noussair ask...

Question 17

How do Martin Kocher and his colleagues manipulate the degree of self-control in their study? What do they find with regards to the behaviour of those with depleted self-control, those with non-depleted self-control and those groups consisting of a mixture of both types when it comes to trading a financial asset with declining fundamental value?

Accepted Answer

The answer of How do Martin Kocher and his colleagues...

Quiz 12: Asset Bubbles