Experimental Economics

, Volume 20, Issue 2, pp 481–505

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

  • Sascha Baghestanian
  • Paul Gortner
  • Baptiste Massenot
Original Paper

DOI: 10.1007/s10683-016-9493-0

Cite this article as:
Baghestanian, S., Gortner, P. & Massenot, B. Exp Econ (2017) 20: 481. doi:10.1007/s10683-016-9493-0

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 

Supplementary material

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

Copyright information

© Economic Science Association 2016

Authors and Affiliations

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

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