Bounded Rationality and the Chinese Warrants Bubbles

Résumé

From 2005 to 2008, over a dozen put warrants traded in China went so deep out of the money that they were almost certain to expire worthless. This bubble is unique in that the underlying stock prices make warrant fundamentals publicly observable and that warrants have predetermined finite maturities. Xiong and Yu(2010) show that the bubble gradually declines and the volatility increases as the warrant approaches to the deadline. However, recent theories on bubbles always predict a boom and bust bubble. In this paper, we propose a model for asset bubbles based on traders’ bounded rationality in a market with finite trading opportunities, and obtain a gradual decreasing bubble and an increasing volatility along the time, which exactly matches the data. In addition, it would be also meaningful to test the behavioral game theories including quantal response equilibrium and coginitive hierarchy in this real data and compare it with the results in experiments.