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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.
KeywordsAsset market experiment Bubbles Cognitive sophistication
JEL ClassificationC91 D12 D84 G11
The authors acknowledge the helpful comments of Michael Greenacre, Frank Heinemann, Joaquim Silvestre, Stefan Palan, Luba Petersen and participants of the Berlin Behavioral Economics colloquium. They also thank Ernan Haruvy, Yaron Lahav, and Charles Noussair for their help with the experimental software, and Pablo Lopez-Aguilar for helping with its implementation. The first author acknowledges financial support by the German Science Foundation through CRC TRR 190. The first two authors acknowledge financial support from the Deutsche Forschungsgemeinschaft (DFG) through CRC 649 “Economic Risk”. The last author acknowledges the financial support from the Spanish Ministerio de Educación, Cultura y Deporte under research project ECO2011-25295. The first author would also like to thank the Small Grants Program of the International Foundation for Research in Experimental Economics and the Deutsche Forschungsgemeinschaft (DFG) through CRC TRR 190 "Rationality and Competition" for financial support.
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