Stylized facts of financial markets, such as excess volatility and bubbles and crashes, have drawn a lot of attention in the last decade. The question as to what explains these bubbles has spurred considerable debate between economists. In a series of so-called Learning to Forecast laboratory experiments, it has been shown that -- even in a very stylized setting -- the self-fulfilling nature of financial market expectations (that is, if traders expect stock prices to increase, and increase their demand of the stock based upon that belief, stock prices will indeed increase) may cause bubbles and crashes in asset prices in the laboratory (see e.g. Hommes, Sonnemans, Tuinstra and van de Velden, 2005, 2008, and Heemeijer, Hommes, Sonnemans and Tuinstra, 2009). However, these laboratory markets are inhabited by traders that have short run horizons: they are only interested in next period's asset price. On actual financial markets some investors may have a longer investment horizon, and this may decrease the incidence of bubbles and crashes in asset prices.
We present results from a Learning to Forecast laboratory experiment designed to study the effects of increasing the forecasting horizon on asset market price volatility. Two competing effects may emerge as the forecasting horizon increases: (i) prices stabilize as non-fundamental predictions affect dynamics to a lesser extent when the forecasting horizon increases and (ii) the more cognitively demanding task to predict the price for more distant future periods destabilizes price dynamics.
Participants to the experiment have to repeatedly predict the price of the asset, where their forecast for future periods determines the current market price, and we pay them for the accuracy of their predictions. We vary the initial history of prices from stable to unstable to investigate how the increasing forecasting horizon affects dynamics under different conditions. We find that increasing the forecasting horizon in markets with stable histories stabilizes dynamics. On the contrary, in markets with an unstable price history, an increase in forecasting horizon increases instability, although, the effect is diminishing. This can partly be explained by the (partial) breakdown of coordination of individual expectations.