The impact of interest rate policy on stock market bubbles and trading behavior

This paper investigates the effect of interest rate policy on stock marketbubbles and trading behavior in experimental asset markets. For this purpose, weintroduce the possibility of investing in interest bearing bonds to the classicallaboratory asset market design of Smith, Suchanek, and Williams (1988). In a seriesof experiments treatment groups face a variable interest rate policy which depends onasset prices, while control groups are subjected to a constant interest rate. We observeonly a small impact of interest policy on bubbles. However, we find a strong impacton investors’ portfolio choice decisions as liquidity in the stock market is reduced atthe same time as interest rates increase.