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Ambiguity in Financial Markets: Herding and Contrarian Behaviour

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  • J L Ford, David Kelsey and W Pang

Abstract

The paper studies the impact of ambiguity on history-dependant beahviour in the standard microstructure model of financial markets. We show that differences in ambiguity attitudes between market makers and traders can generate contrarian and herding behaviour in stock markets where assets are traded sequentially and trading prices are endogenously determined. We also show the mispricing can be only short-term, and in the long-run market is efficient in the sense that the market price aggregates information without distortions.

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File URL: ftp://ftp.bham.ac.uk/pub/RePEc/pdf/herd-finalmay05.pdf
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Bibliographic Info

Paper provided by Department of Economics, University of Birmingham in its series Discussion Papers with number 05-11.

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Length: 41 pages
Date of creation: May 2005
Date of revision:
Handle: RePEc:bir:birmec:05-11

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Postal: Edgbaston, Birmingham, B15 2TT
Web page: http://www.economics.bham.ac.uk
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Related research

Keywords: Ambiguity; Choquet Expected Utility; Generalized Bayesian update; Optimism; Herding; Contrarian behaviour;

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References

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  1. Avery, Christopher & Zemsky, Peter, 1998. "Multidimensional Uncertainty and Herd Behavior in Financial Markets," American Economic Review, American Economic Association, vol. 88(4), pages 724-48, September.
  2. V. V. Chari & Patrick J. Kehoe, 2003. "Financial crises as herds: overturning the critiques," Staff Report 316, Federal Reserve Bank of Minneapolis.
  3. Schmeidler, David, 1989. "Subjective Probability and Expected Utility without Additivity," Econometrica, Econometric Society, vol. 57(3), pages 571-87, May.
  4. Sarin, Rakesh K & Wakker, Peter, 1992. "A Simple Axiomatization of Nonadditive Expected Utility," Econometrica, Econometric Society, vol. 60(6), pages 1255-72, November.
  5. Sushil Bikhchandani & David Hirshleifer & Ivo Welch, 2010. "A theory of Fads, Fashion, Custom and cultural change as informational Cascades," Levine's Working Paper Archive 1193, David K. Levine.
  6. David Hirshleifer & Siew Hong Teoh, 2003. "Herd Behaviour and Cascading in Capital Markets: a Review and Synthesis," European Financial Management, European Financial Management Association, vol. 9(1), pages 25-66.
  7. Tallon, Jean-Marc, 1998. "Asymmetric Information, Nonadditive Expected Utility, and the Information Revealed by Prices: An Example," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 39(2), pages 329-42, May.
  8. Kelsey, David, 1995. "Dutch Books Arguments and Learning in a Nonexpected Utility Framework," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 36(1), pages 187-206, February.
  9. Michael Kilka & Martin Weber, 2001. "What Determines the Shape of the Probability Weighting Function Under Uncertainty?," Management Science, INFORMS, vol. 47(12), pages 1712-1726, December.
  10. LOVO, Stefano & DECAMPS, Jean-Paul, 2002. "Risk aversion and herd behavior in financial markets," Les Cahiers de Recherche 758, HEC Paris.
  11. Wakker, Peter P, 2001. "Testing and Characterizing Properties of Nonadditive Measures through Violations of the Sure-Thing Principle," Econometrica, Econometric Society, vol. 69(4), pages 1039-59, July.
  12. Gilboa, Itzhak, 1987. "Expected utility with purely subjective non-additive probabilities," Journal of Mathematical Economics, Elsevier, vol. 16(1), pages 65-88, February.
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