Hostname: page-component-7b9c58cd5d-bslzr Total loading time: 0.001 Render date: 2025-03-17T07:35:12.431Z Has data issue: false hasContentIssue false
  • English
  • Français

Compensation schemes, liquidity provision, and asset prices: an experimental analysis

Published online by Cambridge University Press:  14 March 2025

Sascha Baghestanian ,
Paul Gortner  and
Baptiste Massenot
Sascha Baghestanian*
Affiliation:
Goethe University Frankfurt, Frankfurt, Germany
Paul Gortner*
Affiliation:
Goethe University Frankfurt, Frankfurt, Germany
Baptiste Massenot*
Affiliation:
Goethe University Frankfurt, Frankfurt, Germany
*
[email protected]
[email protected]
[email protected]
Get access Rights & Permissions [Opens in a new window]

Abstract

In an experimental setting in which investors can entrust their money to traders, we investigate how compensation schemes affect liquidity provision and asset prices, two outcomes that are important for financial stability. Compensation schemes can drive a wedge between how investors and traders value the asset. Limited liability makes traders value the asset more than investors. To limit losses, investors should thus restrict liquidity provision to force traders to trade at a lower price. By contrast, bonus caps make traders value the asset less than investors. This should encourage liquidity provision and increase prices. In contrast to these predictions, we find that under limited liability investors increase liquidity provision and asset price bubbles are larger. Bonus caps have no clear effect on liquidity provision and they fail to tame bubbles. Overall, giving traders skin in the game fosters financial stability.

Keywords

CompensationLiquidityExperimental asset marketsBubbles

JEL classification

G12: Asset Pricing • Trading Volume • Bond Interest Rates C91: Laboratory, Individual Behavior C90: General
Type
Original Paper
Information
Experimental Economics , Volume 20 , Issue 2 , June 2017 , pp. 481 - 505
Copyright
Copyright © 2016 Economic Science Association

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

Footnotes

Electronic supplementary material The online version of this article (doi:https://doi.org/10.1007/s10683-016-9493-0) contains supplementary material, which is available to authorized users.

References

Agarwal, V, Daniel, ND, & Naik, NY (2009). Role of managerial incentives and discretion in hedge fund performance. The Journal of Finance, 64(5), 2221–2256. 10.1111/j.1540-6261.2009.01499.xCrossRefGoogle Scholar
Bebchuk, LA, & Spamann, H (2009). Regulating bankers’ pay. Georgetown Law Journal, 98(2), 247–287.Google Scholar
Breaban, A, & Noussair, CN (2015). Trader characteristics and fundamental value trajectories in an asset market experiment. Journal of Behavioral and Experimental Finance, 8, 1–17. 10.1016/j.jbef.2015.07.005CrossRefGoogle Scholar
Caginalp, G, Porter, D, & Smith, V (1998). Initial cash/asset ratio and asset prices: An experimental study. Proceedings of the National Academy of Sciences, 95(2), 756–761. 10.1073/pnas.95.2.756CrossRefGoogle ScholarPubMed
Crosetto, P, & Filippin, A (2013). The Bomb risk elicitation task. Journal of Risk and Uncertainty, 47(1), 31–65. 10.1007/s11166-013-9170-zCrossRefGoogle Scholar
DeLong, JB, Shleifer, A, Summers, LH, & Waldmann, RJ (1990). Positive feedback investment strategies and destabilizing rational speculation. The Journal of Finance, 45(2), 379–395. 10.1111/j.1540-6261.1990.tb03695.xCrossRefGoogle Scholar
Elton, EJ, Gruber, MJ, & Blake, CR (2003). Incentive fees and mutual funds. The Journal of Finance, 58(2), 779–804. 10.1111/1540-6261.00545CrossRefGoogle Scholar
Fischbacher, U (2007). z-Tree: Zurich toolbox for ready-made economic experiments. Experimental Economics, 10(2), 171–178. 10.1007/s10683-006-9159-4CrossRefGoogle Scholar
Greiner, B (2003). An online recruitment system for economic experiments. Forschung und wissenschaftliches Rechnen, 63, 79–93.Google Scholar
Großer, J, & Reuben, E (2013). Redistribution and market efficiency: An experimental study. Journal of Public Economics, 101, 39–52. 10.1016/j.jpubeco.2013.02.002CrossRefGoogle Scholar
Holmen, M, Kirchler, M, & Kleinlercher, D (2014). Do option-like incentives induce overvaluation? Evidence from experimental asset markets. Journal of Economic Dynamics and Control, 40, 179–194. 10.1016/j.jedc.2014.01.002CrossRefGoogle Scholar
Isaac, RM, & James, D (2003). Boundaries of the tournament pricing effect in asset markets: Evidence from experimental markets. Southern Economic Journal, 69(4), 936–951. 10.2307/1061659Google Scholar
James, D, & Isaac, R (2000). Asset markets: How they are affected by tournament incentives for individuals. The American Economic Review, 90(4), 995–1004. 10.1257/aer.90.4.995CrossRefGoogle Scholar
Jensen, MC, & Meckling, WH (1976). Theory of the firm: Managerial behavior, agency costs and ownership structure. Journal of Financial Economics, 3(4), 305–360. 10.1016/0304-405X(76)90026-XCrossRefGoogle Scholar
Kleinlercher, D, Huber, J, & Kirchler, M (2014). The impact of different incentive schemes on asset prices. European Economic Review, 68, 137–150. 10.1016/j.euroecorev.2014.02.010CrossRefGoogle Scholar
Murphy, RO, Ackermann, KA, & Handgraaf, M (2011). Measuring social value orientation. Judgement and Decision Making, 6(8), 771–781.CrossRefGoogle Scholar
Powell, O (2016). Numeraire independence and the measurement of mispricing in experimental asset markets. Journal of Behavioral and Experimental Finance, 9, 56–62. 10.1016/j.jbef.2015.11.002CrossRefGoogle Scholar
Rajan, RG (2006). Has finance made the world riskier?. European Financial Management, 12(4), 499–533. 10.1111/j.1468-036X.2006.00330.xCrossRefGoogle Scholar
Robin, S., Straznicka, K. & Villeval, M.-C. (2012). Bubbles and incentives: An experiment on asset markets. Working Paper.CrossRefGoogle Scholar
Smith, VL, Suchanek, GL, & Williams, AW (1988). Bubbles, crashes, and endogenous expectations in experimental spot asset markets. Econometrica, 56(5), 1119–1151. 10.2307/1911361CrossRefGoogle Scholar
Stöckl, T, Huber, J, & Kirchler, M (2010). Bubble measures in experimental asset markets. Experimental Economics, 13(3), 284–298. 10.1007/s10683-010-9241-9CrossRefGoogle Scholar
Supplementary material: File

Baghestanian et al. supplementary material

Baghestanian et. al. supplementary material
Download Baghestanian et al. supplementary material(File)
File 490.4 KB