Froberg, Matthew (University of Utah)
Faculty Advisor: Asparouhove, Elena (University of Utah, David Eccles School of Business (Finance))
This research examines two fundamental topics of economics: accuracy of prices and the effect of market participation on individuals. In particular, it asks how security structure affects price and allocational efficiency through the equilibration process.
Security structure is defined as the payoff correlation structure between tradable assets. Economists agree that the markets they are studying are in equilibrium and also that there are equilibration forces that will drive markets towards equilibrium if they are not already there (see, for example, Arrow and Hahn (1971)). There is much less agreement, however, on what these equilibration forces are. Furthermore, it is very difficult to learn about these driving forces through the analysis of historical data because not enough is known about the fundamentals (wealth, human capital, and preferences of individuals) of past markets. This represents a great opportunity for experimental finance, where markets can be created in a laboratory setting allowing researchers to know, control, and change the fundamentals of the markets they create. This research examines what asset structures yield the most efficient allocations as a result of imposed fundamentals. The trading platform is Continuous Double Auction and is implemented in a software called Flexemarkets (flexemarkets.com). The main hypothesis is that markets consisting of securities that correlate negatively will exhibit the highest allocational efficiency. Data collection with human traders will be collected in the months of November and December. Pilot sessions with humans suggest that negatively correlated assets aid price discovery but more data is needed to address allocational efficiency.
The question regarding asset structure and its effect on financial well-being is especially relevant given the increasing popularity of index funds (see Bogle (2016)), which are typically positively correlated. Results of the experiment could yield substantial policy implications concerning what types of security designs lead to optimal allocational outcomes.