Experimental finance is the study of financial markets and their behavior through laboratory or field experiments. These experiments often emulate real-world settings, testing new theories and policy ideas at the same time.
Experimental finance researchers have made several groundbreaking discoveries that can be applied to various areas of economic research, such as financial market theory and behavior, natural resource economics, and the deregulation of industries like electric power or water.
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One of the most fascinating findings was that markets can equilibrium even when there are few sellers and buyers. This discovery challenged the conventional wisdom that an infinite number of buyers and sellers must exist for competitive equilibrium to occur. Indeed, when Smith tested his hypothesis using a double-oral auction, his subjects produced competitive equilibrium even without knowing about others’ buying and selling habits.
This discovery came as a shock to economists, who had long held that markets must have perfect information in order to achieve competitive equilibrium. This discovery opened the door to experimental economics – an entirely new field of investigation.
Experimental economics was initially developed to test fundamental predictions from economic theory using simple models of supply and demand. For instance, graphing supply and demand with price on one axis and quantity on another can give accurate predictions as to how many units would voluntarily enter a market at various prices.
These insights assist scientists and policymakers in comprehending how markets function, what rules govern trading, and how people react to changes in those rules. Furthermore, they provide a way to “bench test” policy options by comparing the expected outcomes of various sets of rules.
Experimental finance has grown considerably over the past two decades and now forms a distinct subfield of finance. This can be seen in the rising percentage of experimental publications in many finance journals, but there remain challenges and limitations associated with this type of research.
Despite these difficulties, experimental finance is rapidly gaining recognition and increasing in importance. It takes an interdisciplinary approach that draws from social, psychological, and physical sciences to explain the dynamics of financial decision-making and markets.
Its success has provided invaluable insights into how and why people make decisions. These discoveries have contributed to our understanding of market and behavioral models, as well as highlighting areas for further investigation.
Research in experimental finance must grapple with issues such as the role of monetary and nonmonetary variables, subject pool choice, and methods for measuring effects such as emotions or risk. Furthermore, studying rare or extreme events is becoming an increasingly popular field that could benefit from experimental approaches.
Over the past five years, experimental finance has seen remarkable progress. It is increasingly distinguishing itself from empirical finance with increasing publication rates and new techniques for testing models. Furthermore, it focuses on using field experiments and studying interactions between artificial and human agents.
