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Does Volatility Matter? Expectations Of Price Return And Variability In An Asset Pricing Experiment

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Executive Summary

The authors present results of an experiment on expectation formation in an asset market. Participants to the experiment must provide forecasts of the stock future return to computerized utility-maximizing investors, and are rewarded according to how well their forecasts perform in the market. In the Baseline treatment participants must forecast the stock return one period ahead; in the Volatility treatment, they also elicit subjective confidence intervals of forecasts, which they take as a measure of perceived volatility. The realized asset price is derived from a Walrasian market equilibrium equation with non-linear feedback from individual forecasts. The experimental markets exhibit high volatility, fat tails and other properties typical of real financial data.

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