Speculation and Bubbles in an Asset Market

Ball, Sheryl B. and Charles A. Holt. "Classroom Games: Speculation and Bubbles in an Asset Market." Journal of Economic Perspectives. 12 (Winter 1998) 207-218.

This classroom market permits a comparison of the trading prices for an asset with its fundamental value. The exercise provides an interactive framework to facilitate discussion of rational expectations, discounting, backward induction and speculative price bubbles. In this exercise, students trade assets of uncertain value in a sequence of market periods. At least five students are needed as traders, and they begin the game with three colored sheets of paper representing assets, which can be bought or sold, and some hypothetical capital ($20) to finance trading. Traders earn money in three ways: 1) each asset held at the end of a trading period will pay $1 dividend, 2) profits from buying and selling assets, and 3) an asset existing at end of 10 trading periods pay $6. After the $1 dividend is paid at the end of each trading period, a six-sided die is rolled to determine if each asset will remain (1/6 chance of being destroyed). A destroyed asset is torn in half. The trading team keeps track of their earning on forms provided in the appendix. Instructions for the trading of assets is also included in the appendix. Trading is conducted as an explicit double auction, moderated by the instructor/auctioneer. Classroom discussion follows.