Working Paper: NBER ID: w16187
Authors: Bruce I. Carlin; Shimon Kogan
Abstract: We perform an experimental study of complexity to assess its effect on trading behavior, price volatility, liquidity, and trade efficiency. Subjects were asked to deduce the value of a particular asset from information they were given about the composition and price of several portfolios. Following that, subjects traded with each other anonymously in a well-defined, simple bargaining process. Portfolio problems ranged from requiring simple analysis to more complicated computation. Complexity altered subjects' bidding strategies, decreased liquidity, increased price volatility, and decreased trade efficiency. Female subjects were affected more by complexity (e.g., lower trade frequency), although they achieved higher payoffs in the complex treatment. Our analysis suggests that complexity may be a driver of volatility and liquidity in financial markets and provides novel testable empirical predictions.
Keywords: complex assets; trading behavior; price volatility; liquidity; trade efficiency
JEL Codes: C92; G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| complexity (C60) | liquidity (E41) |
| complexity (C60) | price volatility (G13) |
| complexity (C60) | trade efficiency (F14) |
| complexity (C60) | trading behavior (G41) |