Deck 12: Asset Bubbles

Question 1

A "call market" is one where:

A) buyers and sellers can engage in decentralized trades between one another based on their respective bids and asks.
B) sellers post a price for their product and buyers are free to either buy or not buy at that price.
C) buyers post a price at which they are willing to buy and sellers are free to either sell or not sell at that price.
D) the buyer bids and seller asks are used to generate the underlying demand and supply curves, solve for the equilibrium price and then all trade takes place at that calculated equilibrium price.

Answer 1

the buyer bids and seller asks are used to generate the underlying demand and supply curves, solve for the equilibrium price and then all trade takes place at that calculated equilibrium price.

Question 2

A "double auction" is a market where:

A) buyers and sellers can engage in decentralized trades between one another based on their respective bids and asks.
B) sellers post a price for their product and buyers are free to either buy or not buy at that price.
C) buyers post a price at which they are willing to buy and sellers are free to either sell or not sell at that price.
D) the buyer bids and seller asks are used to generate the underlying demand and supply curves, solve for the equilibrium price and then all trade takes place at that calculated equilibrium price.

Answer 2

buyers and sellers can engage in decentralized trades between one another based on their respective bids and asks.

Question 3

If in any period the dividend on a share takes one of four values, $0.00, $0.08, $0.28 or $0.60 with equal probability then for a share that trades for 10 period and becomes value-less after that, the expected dividend is:

A) $0.24.
B) $3.60.
C) $2.40.
D) $0.00.

Answer 3

$2.40.

Question 4

Suppose in any period dividend on a share takes one of four values, $0.00, $0.04, $0.14 or $0.30 with equal probability in each period and trades for 15 periods after which it becomes valueless. At the beginning of the 11^th period, the expected dividend from this share is:

A) $0.60.
B) $3.60.
C) $2.25.
D) $0.15.

Question 5

Suppose in any period the dividend on a share takes one of four values: $0.00, $0.04, $0.14 or $0.30 with equal probability in each period and trades for 15 periods after which it becomes valueless. At the beginning of the 1^st period, the expected dividend from this share is:

A) $0.75.
B) $3.60.
C) $1.80.
D) $0.15.

Question 6

Suppose in any period the dividend on a share takes one of four values: $0.00, $0.08, $0.28 or $0.60 with equal probability. The share trades for 15 periods and then become valueless. You have just bought this share prior to Period 9 for $2.48. This implies that:

A) If you do not manage to sell this share to anyone else before trading ends, then you will be looking at losing $0.80.
B) If you manage to sell the share to another trader before trading ends for $2.78, then you have enjoyed a speculative gain of $1.10.
C) Even if you manage to sell the share to another trader before trading ends for $2.78, then you have made a loss of $0.82.
D) You would make a speculative gain simply by hanging on to this asset till then end of trading.

Question 7

Suppose in any period a share dividend takes one of four values: $0.00, $0.08, $0.28 or $0.60 with equal probability. The asset trades for 15 periods and then become valueless. Period 9 has ended and Period 10 has just begun. There are a number of offers to sell that you could consider. Which of the following statements is true?

A) You should not consider buying this share at any price higher than $1.44 unless you are certain to make a speculative gain on the share.
B) You should not consider buying this share at any price lower than $1.44.
C) You should consider buying this share at any price since there are plenty of periods left and you will almost certainly find another trader willing to pay a higher price.
D) You should not consider buying this share regardless of the sale price.

Question 8

Suppose a share is trading for $25 in the current period. You enter into a contract with another trader that once the last trading period ends you will sell 100 shares to this other trader for $18 per share. You are expecting to make a profit from this contract. This implies that:

A) You expect the market price to drop to less than $18 per share by the last trading period.
B) You expect the market price to remain above $18 per share even in the last trading period
C) You expect the market price to drop to less than $25 but stay above $18 by the last trading period.
D) You expect the market price to go up above $25 even in the last trading period.

Question 9

Suppose a share is trading for $25 in the current period. You enter into a contract with another trader that once the last trading period ends you will sell 100 shares to this other trader for $18 per share. This implies that:

A) You will make a profit of $200 if the market price is $16 per share by the last trading period.
B) You will make a loss of $200 if the market price drops to $16 per share by the last trading period.
C) You will make a profit of $200 if the market price is $20 per share by the last trading period.
D) You will make a profit of $700 if the market price stays at $25 till the last trading period.

Question 10

Suppose a share is trading for $25 in the current period. You borrow the current market value of 100 shares, i.e., $2500 from a broker. You will need to repay 100 shares to the broker after the last trading period.

A) You will make a profit of $2000 if the market price is $16 per share by the last trading period.
B) You will make a profit of $900 if the market price drops to $16 per share by the last trading period.
C) You will make a loss of $900 if the market price is $16 per share by the last trading period.
D) You will make a loss of $1000 if the market price stays at $25 till the last trading period.

Question 11

Suppose a share is trading for $25 in the current period. You borrow the current market value of 100 shares, i.e., $2500 from a broker. You will need to repay 100 shares to the broker after the last trading period.

A) You will make a profit of $2000 if the market price is $16 per share by the last trading period.
B) You will make a loss of $400 if the market price drops to $20 per share by the last trading period.
C) You will make a loss of $900 if the market price stays at $25 per share by the last trading period.
D) You will neither make a loss nor a profit if the market price stays at $25 till the last trading period.

Question 12

Suppose a share has a flat fundamental value of $7. Currently the share is trading at $17.50 per share. You enter into a contract with another trader that once the last trading period ends you will sell 100 shares to this other trader for $10.50 per share. You are anticipating making at least $250 profit.

A) You anticipate that the market price will definitely crash to the fundamental value by the last trading period.
B) You anticipate that the market price will definitely crash to a price of $10.50 per share by the last trading period.
C) You anticipate that the market price will definitely crash to a price of no greater than $8 per share by the last trading period.
D) You anticipate that the market price will reach $13 per share by the last trading period.

Question 13

Suppose a share has a flat fundamental value of $7. Currently the share is trading at $17.50 per share. You enter into a contract with another trader that once the last trading period ends you will sell 100 shares to this other trader for $10.50 per share. But, by the last market period the share is trading at $13.50 per share. This implies that in this case:

A) You will make a profit of $300.
B) You will make a profit of $350.
C) You will have to renege on your promise to sell since the market price is above $10.50.
D) You will make a loss of $300.

Question 14

Which of the following statements about a share with a flat fundamental value is incorrect?

A) A share with a flat fundamental value can be redeemed at a fixed value at the end of the trading period.
B) A flat fundamental value is a way of approximating a share that is long or infinitely lived.
C) A flat fundamental value implies that the time-path of expected dividends can be represented by a horizontal straight line.
D) A flat fundamental value implies that the time-path of expected dividends can be represented by downward sloping straight line.

Question 15

Which of the following statements about a share with a declining fundamental value is correct?

A) A share with declining fundamental value is valueless at the end of the trading period.
B) A declining fundamental value is a way of approximating a share that is long or infinitely lived.
C) A declining fundamental value implies that the time-path of expected dividends can be represented by a horizontal straight line.
D) A declining fundamental value implies that this type of share will never display asset bubbles that are often observed with a flat fundamental value.

Question 16

Which of the following statements about a share with a declining fundamental value is correct?

A) A share with a declining fundamental value can each be redeemed for a pre-announced amount of money at the end of the trading period.
B) A declining fundamental value is a way of approximating a share that is long or infinitely lived.
C) A declining fundamental value implies that the time-path of expected dividends can be represented by a downward sloping straight line.
D) A declining fundamental value implies that this type of share will never display asset bubbles that are often observed with a flat fundamental value.

Question 17

Which of the following statements about a share with a flat fundamental value is correct?

A) A share with a flat fundamental value implies that the share is rendered valueless at the end of the trading period.
B) A flat fundamental value is a way of approximating a share that is long or infinitely lived.
C) A flat fundamental value implies that the time-path of expected dividends can be represented by a downward sloping straight line.
D) A flat fundamental value implies that the share prices will not exhibit the bubble and crash pattern that we see for shares with declining fundamental value.

Question 18

Which of the following statements about a share with a flat fundamental value is correct?

A) A share with a flat fundamental value implies that the share is rendered valueless at the end of the trading period.
B) A flat fundamental value is a way of approximating a share that is short-lived such as shares in a business dealing with a non-renewable resource such as mining.
C) A flat fundamental value implies that the time-path of expected dividends can be represented by a horizontal straight line.
D) A flat fundamental value implies that the share prices will not exhibit the bubble and crash pattern that we see for shares with declining fundamental value.

Question 19

One way to think of "adaptive expectations", is that they:

A) Prevent asset bubbles from forming.
B) Take into account all available information and expectations.
C) Are backward looking or trend following.
D) Lead to a declining fundamental asset value.

Question 20

Which of the following is true of the results reported in the Kocher et al. study on self-control and asset bubbles?

A) Groups of traders with depleted self-control exhibit similar bubble and crash pattern as groups of traders whose self-control has not been depleted.
B) Groups with a mixture of depleted and non-depleted self-control traders exhibit similar bubble and crash pattern as groups with exclusively depleted self-control traders.
C) Groups with a mixture of depleted and non-depleted self-control traders exhibit similar bubble and crash pattern as groups with exclusively non-depleted self-control traders.
D) Groups of traders with depleted self-control exhibit smaller price bubbles compared to groups of traders whose self-control has not been depleted.

Question 21

Consider a share with a declining fundamental value that trades for 10 periods. Which of the following phenomena would be most consistent with prices tracking fundamental value?

A) Average market price peaks in period 10.
B) Average market prices peaks before Round 5.
C) Average market price peaks after Round 5.
D) Average market price peaks in Round 1.

Question 22

Suppose the dividend paid on a share takes one of four values, each with equal probability: $0.00, $0.08, $0.28 and $0.60. The share trades for 15 periods. The prevailing market interest rate is 10%. If you wanted to implement a flat fundament value for this share then you should set that fundamental value equal to:

A) $0.24.
B) $3.60.
C) $0.024.
D) $2.40.

Question 23

Suppose a share has the flat fundamental value of $3.60. The share trades for 15 periods. The market interest rate is 10%. This implies that the per period expected dividend on the share must be:

A) $0.24.
B) $3.60.
C) $0.36.
D) $2.40.

Question 24

Suppose the dividend paid on a share takes one of four values, each with equal probability: $0.00, $0.08, $0.28 and $0.60. The share trades for 15 periods. You have chosen to implement a flat fundamental value of $4.80 for this share. This means that you must set the interest rate on cash holdings at:

A) $10%.
B) $25%.
C) $0%.
D) $5%.

Question 25

Suppose you want to implement a market for a share with a flat fundamental value (P). Denote by E the per period expected dividend for this share and by R the market interest rate. Which of the following formula represents the correct expression for the flat fundamental value in this case?

A) P = R/E.
B) P = E/R.
C) P = E/{1+R}.
D) P = E*R.

Question 26

Which of the following is not a likely explanation for the bubble and crash pattern frequently seen in markets for financial assets?

A) Traders chase speculative gains.
B) Traders have adaptive or trend-following expectations.
C) Traders may all be rational but they are not convinced about the rationality of everyone else.
D) Traders have rational expectations.

Question 27

Lei, Noussair and Plott's "excess trading" hypothesis regarding trading in financial asset markets relates to which of the following?

A) Lots of shares change hands during a price boom, but not during the crash.
B) Traders may engage in large volumes of buying and selling primarily because there is nothing else to do during the course of the experiment to keep them occupied.
C) The familiar bubble and crash pattern occurs in markets for financial assets primarily because buyers can only purchase but not sell assets while and sellers can only sell but not purchase assets.
D) Contrary to the efficient markets hypothesis, average market price tends to peak toward the end of the experimental session.

Question 28

Which of the following is an accurate description of the "no speculation" asset market set up in the study by Lei, Noussair and Plott.

A) Buyers and sellers can engage in a continuous double auction; this means that at any point of time, buyers can submit bids to buy or accept standing offers to sell while sellers can submit offers to sell or accept standing bids to buy.
B) Buyers can only buy shares but cannot re-sell shares once purchased. Sellers can only sell shares but cannot purchase shares or re-purchase shares sold.
C) The buyer bids to buy and seller offers to sell are aggregated to create the underlying demand and supply curves and all trade takes place at the calculated market equilibrium price.
D) Bids to buy must be ascending, i.e., any bid must be higher than the current lowest bid. Offers to sell must be descending, i.e., any offer must be higher than the current highest offer.

Question 29

In their 1988 study Smith et al. reported that asset prices lie above forecast prices during booms and below forecast prices during the slump. In their work, Haruvy, Lahav and Noussair suggest that this may be possibly due to the fact:

A) In forecasting prices, traders look not only at what is happening in the current market but also look back to earlier markets, which typically exhibit larger bubbles than the current market.
B) That traders have rational expectations and expect everyone else to behave rationally as well.
C) That traders chase speculative gains and in doing so drive prices up, which eventually have to come down.
D) That traders all behave rationally but are not convinced about the rationality of other traders.

Question 30

In the Haruvy, Lahav and Noussair study, the participants are asked to enter their prediction for the assets' market price for all remaining periods rather than just for the upcoming period. It is likely that doing so would:

A) Alter the frame of reference and get participants to engage in backward induction by thinking about feasible ranges for the market price in the last period and then working their way backward.
B) Cause the traders to ignore the fundamental value or the current price and chase further speculative gains.
C) Lead traders to become more convinced about the rationality of other traders.
D) Prevent traders from engaging in excess trading by buying and selling more than the optimal amounts of assets.

Question 31

In the Haruvy, Lahav and Noussair study, the participants are asked to enter their prediction for the assets' market price for all remaining periods rather than just for the upcoming period. The authors find that when they do this with participants taking part in a series of markets lasting 15 periods each:

A) The peak average market price occurs in earlier rounds in later markets in keeping with the fundamental value of the asset.
B) Cause the traders to ignore the fundamental value or the current price and chase further speculative gains.
C) Lead traders to become more convinced about the rationality of other traders.
D) Prevent traders from engaging in excess trading by buying and selling more than the optimal amounts of assets.

Question 32

Martin Kocher and his colleagues find that groups consisting of a mixture of depleted and non-depleted self-control traders behave similar to groups of depleted self-control traders in terms of the pattern of bubbles and crashes. What do Kocher et al. suggest as a reason for this similarity in behaviour?

Question 33

The familiar pattern of bubbles and crashes in markets for financial assets can be caused by a number of factors including (1) chasing speculative gains and (2) lack of common knowledge of the rationality of traders. Briefly explain what is meant by these two concepts.

Question 34

Why might a researcher wish to study an asset with a flat fundamental value? Assuming a redemption value of P, a per period expected dividend of E, and a market interest rate of R, explain how you would set the redemption value of this asset at the end of the trading period to generate a flat fundamental value.

Question 35

Lei, Noussair and Plott argue that the familiar bubble and crash pattern observed in markets for financial assets may be caused by "excess trading" on the part of traders in the context of lab experiments. What do the authors mean by "excess trading"? How do they test this hypothesis by setting up a second market and what are the characteristics of that market?

Question 36

Why do Haruvy, Lahav and Noussair ask their participants to make predictions for asset prices not only for the next period but for all remaining periods? What is the implication for making these forecasts for future periods on the incidence of price peaks in those markets?

Question 37

How do Martin Kocher and his colleagues manipulate the degree of self-control in their study? What do they find with regards to the behaviour of those with depleted self-control, those with non-depleted self-control and those groups consisting of a mixture of both types when it comes to trading a financial asset with declining fundamental value?