For additional information:
Dr. Dorla Evans, (205) 890-6024
[email protected]
Phillip Gentry, (205) 890-6414
[email protected]

Big 'winners' may play a different game

The biggest winners in an investment market may be playing the game
according to their own rules, rather than following the "rational"
economic rules followed by most investors.

A study using an experimental investment market at UAH found that the
most successful investors were not the people who invested most
rationally, as defined by commonly applied economic theories, said Dr.
Dorla Evans, a professor of finance.

The experiment used student volunteers as the traders. Each was given
$10, which they could use to bid on chances to participate in lotteries
based on the roll of a die. Lotteries had different payoffs and different
odds.

Expected utility theory, which is frequently used to analyze trading in
various markets, says each lottery should have a "rational" value, based
on the payoff and the odds, Evans said. "The theorists assume that in any
market you have a group of smart, rational investors who follow the
rules. They would exploit the irrational investors and help set rational
market prices. And they would make the most money."

In the experimental market, however, the most "rational" traders were not
the biggest winners. While rational traders were the group that most
often set the market price for lotteries, the biggest winners exploited
the rules of the market. They bid higher than the real value, knowing the
rational traders would set a reasonable market price.

"You can't say the wealthy traders were irrational," said Evans. "They
were playing a different game. They could count on these rational players
letting them make lots of money.

"The rational players, the ones who set the market prices, were the
middle of the road guys who wanted to sleep at night," she said. "They
were willing to accept the lower risk, lower return trade off. But they
paid a penalty for adding rationality to that market."