Trading in Experimental Asset Markets under Knightian Uncertainty

Recent theoretical research shows that in asset markets vague state probabilities lead to price volatility, trading inertia, and may worsen risk-sharing efficiency, whereas Subjective Expected Utility theory implies that prices, volumes, and final allocations for risky and uncertain assets should be equivalent. We investigate experimentally whether prices, trading, and final allocations are affected in a market in which traders form subjective probabilities of payoffs. Results show that average prices for risky and uncertain assets converge. Price bubbles form in both markets even if subjects can arbitrage by trading fully hedged portfolios. Equivalent volumes of trade and risk-sharing efficiency are observed. JEL code: D81