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Do option-like incentives induce overvaluation? Evidence from experimental asset markets

Journal article
Authors Martin Holmén
Michael Kirchler
Daniel Kleinlercher
Published in Journal of Economic Dynamics and Control
Volume 40
Pages 179-194
ISSN 0165-1889
Publication year 2014
Published at Centre for Finance
Department of Economics
Pages 179-194
Language en
Links dx.doi.org/10.1016/j.jedc.2014.01.0...
Keywords Experimental finance, Incentives, Market efficiency, Mispricing
Subject categories Economics and Business

Abstract

One potential reason for bubbles evolving prior to the financial crisis was excessive risk taking stemming from option-like incentive schemes in financial institutions. By running laboratory asset markets, we investigate the impact of option-like incentives on price formation and trading behavior. The main results are that (i) we observe significantly higher market prices with option-like incentives than linear incentives. (ii) We further find that option-like incentives provoke subjects to behave differently and to take more risk than subjects with linear incentives. (iii) We finally show that trading at inflated prices is rational for subjects with option-like incentives since it increases their expected payout. © 2014 Elsevier B.V.

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