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Dynamic Trading and Asset Prices: Keynes vs. Hayek

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  • Cespa, Giovanni
  • Vives, Xavier

Abstract

We investigate the dynamics of prices, information and expectations in a competitive, noisy, dynamic asset pricing equilibrium model. We show that prices are farther away from (closer to) fundamentals compared with average expectations if and only if traders over- (under-) rely on public information with respect to optimal statistical weights. Both phenomena, in turn, occur whenever traders speculate on short-run price movements. For a given, positive level of residual payoff uncertainty, over-reliance on public information obtains if noise trade displays low persistence. This defines a "Keynesian" region; the complementary region is "Hayekian" in that prices are systematically closer to fundamentals than average expectations. The standard case of no residual uncertainty and noise trading following a random walk is on the frontier of the two regions and identifies the set of deep parameters for which traders abide by Keynes' dictum of concentrating on an asset "long term prospects and those only." The analysis explains accommodation and trend chasing strategies as well as momentum and reversal.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 7506.

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Date of creation: Oct 2009
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Handle: RePEc:cpr:ceprdp:7506

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Keywords: Average expectations; Efficient market hypothesis; Higher order beliefs; Long and short-term trading; Momentum; Opaqueness; Over-reliance on public information; Reversal;

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References

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  25. Giovanni Cespa, 2000. "Short-term investment and equilibrium multiplicity," Economics Working Papers 520, Department of Economics and Business, Universitat Pompeu Fabra, revised Jun 2002.
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Citations

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Cited by:
  1. Jianjun Miao & Rui Albuquerque, 2008. "Advance Information and Asset Prices," 2008 Meeting Papers 44, Society for Economic Dynamics.
  2. Kristoffer Nimark, 2009. "Speculative dynamics in the term structure of interest rates," Economics Working Papers 1194, Department of Economics and Business, Universitat Pompeu Fabra, revised Sep 2012.
  3. George-Marios Angeletos & Guido Lorenzoni & Alessandro Pavan, 2007. "Wall Street and Silicon Valley: A Delicate Interaction," NBER Working Papers 13475, National Bureau of Economic Research, Inc.
  4. Allen, Franklin & Vayanos, Dimitri & Vives, Xavier, 2014. "Introduction to financial economics," Journal of Economic Theory, Elsevier, vol. 149(C), pages 1-14.

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