Experiences, demand for risky investments, and implications for price dynamics

Personal experiences can impact investors’ risk taking, and this can explain market phenomena such as time-varying risk premia, asset price bubbles or wage–price spirals. Establishing the link from individual experiences to market outcomes is challenging, as together with experiences, several decision-relevant factors simultaneously change. The present work investigates the impact of prior experiences on subsequent investments in a laboratory experiment without confounds, which allows for the control of various factors that usually are correlated with experience. The results show that high (low) previously experienced outcomes lead to more (less) investment in a risky asset, even in a condition where experiences do not provide new information and should be ignored. A reinforcement learning model captures the observed individual behavior and allows us to explain market price dynamics. The experience effect on risk taking informs behavioral theories of markets and provides a cognitive explanation for trend-following and self-enforcing market dynamics.