Peaks and valleys

Abstract

Purpose This paper aims to study how the trajectory of fundamental values affects price discovery in an experimental asset market. Design/methodology/approach An experiment is conducted with two treatments, in which the time path of fundamentals differs between treatments. In the peak treatment, fundamentals first rise and then fall, while in the valley treatment fundamentals first fall and then recover. The experiment allows market prices to be compared to fundamental values. Findings Both peak and valley treatments experience bubbles when traders are inexperienced. However, price discovery is more rapid and complete in the peak than in the valley treatment. In the peak treatment, prices track the value, the direction of the trend, and changes in trend, more closely than in the valley treatment. Originality/value This paper documents the first experimental results regarding pricing behavior in markets with non‐monotonic fundamentals. It creates an environment (the valley treatment) in which convergence to close to fundamentals does not occur even with repetition of the market under identical conditions. The results demonstrate that the likelihood that an asset market tracks fundamentals depends on the time path of fundamentals.

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