Interest on Cash, Fundamental Value Process and Bubble Formation: An Experimental Study

Abstract: We explore the flexibility created by the introduction of interest payments on cash holdings to the design of asset-trading experiments along the line of Smith et al. (1988). We conduct an experiment using this framework, and find that the fundamental value generating process greatly affects trading behaviors and prices. In particular, an environment where the asset has increasing fundamental values and positive expected dividend payments is conducive to fundamental trading. In addition, we provide some evidence that increasing the opportunity cost of speculation on the asset market in the form of interest payments on cash has limited success in containing price inflation.