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Is Rational Speculation in the Presence of Positive Feedback Traders Destabilizing?

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  • Lutz G. Arnold
  • Stephan Brunner

Abstract

DeLong (1990a) et al. show that in the presence of positive feedback traders rational speculation can be destabilizing, in that it drives the price of a risky asset above its expected value. A generalization of their seminal model with additional trading dates and an additional informative signal yields further interesting insights: it helps clarify when prices overreact, underreact, or even move in the "wrong" direction; when rational speculation is destabilizing or stabilizing; and whether overreaction is a symptom of market inefficiency or a manifestation of informational efficiency.

Suggested Citation

  • Lutz G. Arnold & Stephan Brunner, 2012. "Is Rational Speculation in the Presence of Positive Feedback Traders Destabilizing?," Working Papers 119, Bavarian Graduate Program in Economics (BGPE).
    • Handle: RePEc:bav:wpaper:119_arnoldbrunner
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    File URL: https://bgpe.cms.rrze.uni-erlangen.de/files/2023/07/119_Is-Rational-Speculation-in-the-Presence-of-Positive-Feedback-Traders-Destabilizing.pdf
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    References listed on IDEAS

    as
    1. Lutz G. Arnold, 2009. "Anything is Possible: On the Existence and Uniqueness of Equilibria in the Shleifer-Vishny Model of Limits of Arbitrage," Review of Finance, European Finance Association, vol. 13(3), pages 521-553.
    2. De Bondt, Werner F M & Thaler, Richard, 1985. "Does the Stock Market Overreact?," Journal of Finance, American Finance Association, vol. 40(3), pages 793-805, July.
    3. Shiller, Robert J, 1981. "Do Stock Prices Move Too Much to be Justified by Subsequent Changes in Dividends?," American Economic Review, American Economic Association, vol. 71(3), pages 421-436, June.
    4. Jegadeesh, Narasimhan & Titman, Sheridan, 1993. "Returns to Buying Winners and Selling Losers: Implications for Stock Market Efficiency," Journal of Finance, American Finance Association, vol. 48(1), pages 65-91, March.
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    More about this item

    Keywords

    market efficiency; positive feedback trading;

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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