Experimental Finance

This subject introduces students to novel experimental research methods to shed new light on asset pricing theory

OVERVIEW

Using seven examples, students are introduced to a novel research method that has shed new light on the merits and shortfalls of asset pricing theory.

We bring:

  • Financial research beyond its traditional focus on historical records of prices
  • Asset pricing theory to the lab
  • Sense to asset pricing theory

The goal is to introduce students to scientific inquiry using experiments. Students need to  understand that the value of a theory depends on the robustness of its underlying principles and its power in predicting out of sample, thus forcing one to go beyond explaining history of just prices and choices, as traditionally done in empirical finance.

At a more substantive level, the idea is to raise awareness of issues such as:

  • How do financial markets work? Do they reflect the thinking of representative (or "marginal") participants or must one not extrapolate from individuals to the market level? Is only aggregate risk priced? Can there be time-varying risk premia or is the original version of the efficient markets hypothesis better?
  • What are "free markets?" Do they always do "better?" Should health insurance be mandatory? Should decentralized, over-the-counter markets be forbidden? Should banking be more regulated? Should we allow subprime mortgages (loans with which one can buy houses without own down payment)?
  • How do we think formally about bubbles in financial markets? Do they exist? If so, why? Are they bad?

The class makes heavy use of our online markets software, Flex-E-Markets.

The subject is not currently offered at the University of Melbourne.