Experimental Economics

, Volume 20, Issue 2, pp 481–505 | Cite as

Compensation schemes, liquidity provision, and asset prices: an experimental analysis

  • Sascha Baghestanian
  • Paul Gortner
  • Baptiste Massenot
Original Paper
First Online:
Received:
Revised:
Accepted:
  • 208 Downloads

Abstract

In an experimental setting in which investors can entrust their money to traders, we investigate how compensation schemes affect liquidity provision and asset prices, two outcomes that are important for financial stability. Compensation schemes can drive a wedge between how investors and traders value the asset. Limited liability makes traders value the asset more than investors. To limit losses, investors should thus restrict liquidity provision to force traders to trade at a lower price. By contrast, bonus caps make traders value the asset less than investors. This should encourage liquidity provision and increase prices. In contrast to these predictions, we find that under limited liability investors increase liquidity provision and asset price bubbles are larger. Bonus caps have no clear effect on liquidity provision and they fail to tame bubbles. Overall, giving traders skin in the game fosters financial stability.

Keywords

Compensation Liquidity Experimental asset markets Bubbles 

JEL Classification

C90 C91 D03  G02 G12 
This is a preview of subscription content, log in to check access

Notes

Acknowledgments

We gratefully acknowledge research support from the Research Center SAFE, funded by the State of Hessen initiative for research LOEWE.

Supplementary material

10683_2016_9493_MOESM1_ESM.pdf (479 kb)
Supplementary material 1 (PDF 480 kb)

References

  1. Agarwal, V., Daniel, N. D., & Naik, N. Y. (2009). Role of managerial incentives and discretion in hedge fund performance. The Journal of Finance, 64(5), 2221–2256.CrossRefGoogle Scholar
  2. Bebchuk, L. A., & Spamann, H. (2009). Regulating bankers’ pay. Georgetown Law Journal, 98(2), 247–287.Google Scholar
  3. Breaban, A., & Noussair, C. N. (2015). Trader characteristics and fundamental value trajectories in an asset market experiment. Journal of Behavioral and Experimental Finance, 8, 1–17.CrossRefGoogle Scholar
  4. Caginalp, G., Porter, D., & Smith, V. (1998). Initial cash/asset ratio and asset prices: An experimental study. Proceedings of the National Academy of Sciences, 95(2), 756–761.CrossRefGoogle Scholar
  5. Crosetto, P., & Filippin, A. (2013). The Bomb risk elicitation task. Journal of Risk and Uncertainty, 47(1), 31–65.CrossRefGoogle Scholar
  6. DeLong, J. B., Shleifer, A., Summers, L. H., & Waldmann, R. J. (1990). Positive feedback investment strategies and destabilizing rational speculation. The Journal of Finance, 45(2), 379–395.CrossRefGoogle Scholar
  7. Elton, E. J., Gruber, M. J., & Blake, C. R. (2003). Incentive fees and mutual funds. The Journal of Finance, 58(2), 779–804.CrossRefGoogle Scholar
  8. Fischbacher, U. (2007). z-Tree: Zurich toolbox for ready-made economic experiments. Experimental Economics, 10(2), 171–178.CrossRefGoogle Scholar
  9. Greiner, B. (2003). An online recruitment system for economic experiments. Forschung und wissenschaftliches Rechnen, 63, 79–93.Google Scholar
  10. Großer, J., & Reuben, E. (2013). Redistribution and market efficiency: An experimental study. Journal of Public Economics, 101, 39–52.CrossRefGoogle Scholar
  11. Holmen, M., Kirchler, M., & Kleinlercher, D. (2014). Do option-like incentives induce overvaluation? Evidence from experimental asset markets. Journal of Economic Dynamics and Control, 40, 179–194.CrossRefGoogle Scholar
  12. Isaac, R. M., & James, D. (2003). Boundaries of the tournament pricing effect in asset markets: Evidence from experimental markets. Southern Economic Journal, 69(4), 936–951.CrossRefGoogle Scholar
  13. James, D., & Isaac, R. (2000). Asset markets: How they are affected by tournament incentives for individuals. The American Economic Review, 90(4), 995–1004.CrossRefGoogle Scholar
  14. Jensen, M. C., & Meckling, W. H. (1976). Theory of the firm: Managerial behavior, agency costs and ownership structure. Journal of Financial Economics, 3(4), 305–360.CrossRefGoogle Scholar
  15. Kleinlercher, D., Huber, J., & Kirchler, M. (2014). The impact of different incentive schemes on asset prices. European Economic Review, 68, 137–150.CrossRefGoogle Scholar
  16. Murphy, R. O., Ackermann, K. A., & Handgraaf, M. (2011). Measuring social value orientation. Judgement and Decision Making, 6(8), 771–781.Google Scholar
  17. Powell, O. (2016). Numeraire independence and the measurement of mispricing in experimental asset markets. Journal of Behavioral and Experimental Finance, 9, 56–62.CrossRefGoogle Scholar
  18. Rajan, R. G. (2006). Has finance made the world riskier? European Financial Management, 12(4), 499–533.CrossRefGoogle Scholar
  19. Robin, S., Straznicka, K. & Villeval, M.-C. (2012). Bubbles and incentives: An experiment on asset markets. Working Paper.Google Scholar
  20. Smith, V. L., Suchanek, G. L., & Williams, A. W. (1988). Bubbles, crashes, and endogenous expectations in experimental spot asset markets. Econometrica, 56(5), 1119–1151.CrossRefGoogle Scholar
  21. Stöckl, T., Huber, J., & Kirchler, M. (2010). Bubble measures in experimental asset markets. Experimental Economics, 13(3), 284–298.CrossRefGoogle Scholar

Copyright information

© Economic Science Association 2016

Authors and Affiliations

  • Sascha Baghestanian
    • 1
  • Paul Gortner
    • 1
  • Baptiste Massenot
    • 1
  1. 1.Goethe University FrankfurtFrankfurtGermany

Personalised recommendations