Do "Smart People" Learn The Rational Expectations Equilibrium Faster In Financial Markets?

One of the key differences between social economy and natural science lies in the fact that the sum of the individual's expectation about the future will affect the final trend of the economy.Overly optimistic about the economic situation is likely to lead to the global economic and financial market bubble,such as the economic crisis in 1990s,more recently such as the real estate market bubbles in the early years of the 21st century.On the contrary,it is likely that overly pessimistic about the economy will exacerbate the depression.Individuals make the economic decisions based on their expectations about the future economic trends.Economic market is an expectation feedback system.The key of the dynamic expectation theory lies in their hypothesis about the potential market expectations.However,the key problem is to what extent the individuals could learn from their own mistakes in the past and adjust their economic behavior.The problem is mainly determined by the individual's cognitive ability.Therefore,based on the background,this paper will put the Learning-to-forecast experiments and cognitive reflection test together,by controlling other variables in the laboratory environment,study the market price dynamic which contain individuals with different cognitive ability.As far as the possible research outcomes are concerned,this paper has come up with three research hypotheses.Hypothesis 1:the higher the individual cognitive ability is in the market,the smaller the market bubble becomes.We assume that individual cognitive ability is the base of the ability of that market participants to learn and discover the rational expectation equilibrium in the market.Therefore,the higher the individual cognitive ability is,or the more "smart",the more quickly they can be able to learn the rational expectations equilibrium.Hypothesis 2:compared the correlation between the score of the cognitive reflection test and the market bubbles,that is to say,the correct rate of subjects for CRT7 questions has better amplitude for the market bubble.Hypothesis 3:in the forecast experiments,market participants with different cognitive ability will take different expectation strategy.Participants with high cognitive ability are more likely to use adaptive expectation strategy which may stabilize the market.On the contrary,the participants with lower cognitive ability are more likely to use the trend following strategy which may intensify market fluctuation.In order to make the research outcome species,this paper firstly carry out the correlation test between the results of CRT3 and CRT7.This test tells us that the CRT7 can be a good measurement tool of cognitive ability.This paper also makes a correlation test between the correct rate of each problem and the size of corresponding market bubble.This analysis is made to carry out what type of problem can be highly correlated or predictable with the market bubble size.Then,in order to study the convergence speed of asset prices and the individual expectation,this paper measures this by two index which are the median of the distance between the market price and RE and the median of the standard deviation.About the estimation of the market bubble,this paper references related literature by StOckl et al.(2010)using Relative Absolute Deviation and Relative Deviation.Finally,in the analysis of individual expectation strategy,this paper uses the adaptive expectation and the trend rule,only when the parameters are statistically significant lower than 5%and there is no linear correlation,we can say the model is a good description of the expectation strategy.If the two models are able to meet the above conditions,the higher R-square and lower MSE is the index of screening.The results of data analysis in this paper is more consistent with the hypotheses above,but some results could not fully prove that the market bubble with the point of CRT has significant difference.There are 3 reasons that can explain this.Firstly,the number of samples is not enough,from the standard of experimental economics that each treatment has 6 contrary sample,but the market fluctuations in the experimental design can be caused by the individual's behavior easily.Secondly,the CRT is not necessarily able to separate the level of individuals' cognitive ability,in consideration of the individual may also get it right by accident,etc.Thirdly,the understanding ability of the experimental participants is different,it will affect the understanding of the experimental instructions,and then affect their decisions about the economy.The academic contribution of this paper is to study the Learning-to-Forecast Experiments based on the study of Cognitive Reflection Test,study on the impact of forecasting asset price,analyze the cognitive-ability influence on the asset prices from the angle of psychology behavior.From the literature review,this paper is the first study to combine the Cognitive Reflection Test into the Learning-to-Forecast Experiments in the world.At the same time there are 3 shortcomings of this paper.Firstly,the number of samples is not enough,from the standard of experimental economics that each treatment has 6 contrary sample,but the market fluctuations in the experimental design can be caused by the individual's behavior easily.Secondly,the CRT is not necessarily able to separate the level of individuals' cognitive ability.Thirdly,in the experiment,the sex ratio is not strictly controlled,and the sex ratio may affect the experimental data.