Relative Performance Incentives and Price Bubbles in Experimental Asset Markets

Abstract

We study experimental markets in which participants face incentives modeled upon those prevailing in markets for managed funds. Each participant's portfolio is periodically evaluated at market value and ranked by relative performance as measured by short‐term paper returns. Those who rank highly attract a larger share of new fund inflows. In an environment in which prices are typically close to intrinsic value, the effect of these incentives is mild. However, in an environment in which markets are prone to bubble, mispricing is greatly exacerbated by relative performance incentives and becomes even more pronounced with experience.

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