Irrational Trading in a Financial Market

Abstract

A basic assumption in economics is that agents prefer more to less. We find that in an experimental financial market--a large scale political stock market--more than 50 percent of the traders act irrationally in the sense that they violate this fundamental assumption frequently (at least 10 percent of the time). However, the impact of this irrationality seems small, since related losses consist of less than 1 percent of total investments in this market and we find no effect on prices. We do however find systematic bias in prices: Our evidence shows that the sum of the bid prices of all traded stocks exceeds the fundamental value of the market about 10 percent of the time. We argue that another type of irrationality known as 'loss aversion' causes this upward bias.

JEL Classification: G1, D4