A test of the Modigliani Miller Invariance Theorem and Arbitrage in Experimental Asset Markets

Modigliani and Miller (1958) show that a repackaging of asset return streams to equity
and debt has no impact on the total market value of the firm if pricing is arbitrage-free. We test
the empirical validity of this invariance theorem in experimental asset markets with simultaneous
trading in two shares of perfectly-correlated returns. Our data support value invariance for assets
of identical risks when returns are perfectly correlated. However, exploiting price discrepancies
has risk when returns have the same expected value but are uncorrelated, and we find that the
law of one price is violated in this case. Discrepancies shrink in consecutive markets, but seem
to persist even with experienced traders. In markets where overall trader acuity is high, assets
trade closer to parity.