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

Arbeitspapier

In an experimental setting in which investors can entrust their money to traders, we investigate how compensation schemes affect liquidity provision and asset prices. Investors face a trade-off between risk and return. At the benefit of a potentially higher return, they can entrust their money to a trader. However this investment is risky, as the trader might not be trustworthy. Alternatively, they can opt for a safe but low return. We study how subjects solve this trade-off when traders are either liable for losses or not, and when their bonuses are either capped or not. Limited liability introduces a conflict of interest because it 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 decrease prices. In contrast to these predictions, we find that under limited liability investors contribute to asset price bubbles by increasing liquidity provision and that caps fail to tame bubbles. Overall, giving investors skin in the game fosters financial stability.

Object Details

• Language: Englisch

References and Relationships

• Bibliographic citation: Series: SAFE Working Paper ; No. 108

Classification and Topics

• Classification: Wirtschaft ; Design of Experiments: General ; Design of Experiments: Laboratory, Individual ; Asset Pricing; Trading Volume; Bond Interest Rates
• Subject: compensation ; liquidity ; experimental asset markets ; bubbles

Contributors, Places and Time

• Event: Geistige Schöpfung
• (who): Baghestanian, Sascha ; Gortner, Paul ; Massenot, Baptiste
• Event: Veröffentlichung
• (who): Goethe University Frankfurt, SAFE - Sustainable Architecture for Finance in Europe
• (where): Frankfurt a. M.
• (when): 2015

Further information

• DOI: doi:10.2139/ssrn.2613432
• Handle: http://hdl.handle.net/10419/110607
• Last update: 10.03.2025, 11:44 AM CET