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  4. Basic principles of asset pricing theory: Evidence from large-scale experimental financial markets
 
research article

Basic principles of asset pricing theory: Evidence from large-scale experimental financial markets

Bossaerts, P.  
•
Plott, C.
2004
Review of Finance

We report on two sets of large-scale financial markets experiments that were designed to test the central proposition of modern asset pricing theory, namely, that risk premia are solely determined by covariance with aggregate risk. We analyze the pricing within the framework suggested by two theoretical models, namely, the (general) Arrow and Debreu's complete-markets model, and the (more specific) Sharpe-Lintner-Mossin Capital Asset Pricing Model (CAPM). Completeness of the asset payoff structure justifies the former; the small (albeit non-negligible) risks justifies the latter. We observe swift convergence towards price patterns predicted in the Arrow and Debreu and CAPM models. This observation is significant, because subjects always lack the information to deliberately set asset prices using either model. In the first set of experiments, however, equilibration is not always robust, with markets temporarily veering away. We conjecture that this reflects our failure to control subjects' beliefs about the temporal independence of the payouts. Confirming this conjecture, the anomaly disappears in a second set of experiments, where states were drawn without replacement. We formally test whether CAPM and Arrow-Debreu equilibrium can be used to predict price movements in our experiments and confirm the hypothesis. When multiplying the subject payout tenfold (in real terms), to US $ 500 on average for a 3-h experiment, the results are unaltered, except for an increase in the recorded risk premia.

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