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Feedback and the Success of Irrational Investors

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  • Hirshleifer, David

    (Ohio State U)

  • Subrahmanyam, Avanidhar

    (U of California, Los Angeles)

  • Titman, Sheridan

    (U of Texas, Austin)

Abstract

We provide a model in which irrational investors trade based upon considerations that have no inherent connection to fundamentals. However, trading activity affects market prices, and because of feedback from security prices to cash flows, the irrational trades influence underlying cash flows. As a result, irrational investors can, in some situations, earn positive expected profits. These expected profits are not market compensation for bearing risk, and can exceed the expected profits of rational informed investors. Although the trading of irrational investors cause prices to deviate from fundamental values, stock prices follow a random walk.

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File URL: http://www.cob.ohio-state.edu/fin/dice/papers/2004/2004-8.pdf
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Bibliographic Info

Paper provided by Ohio State University, Charles A. Dice Center for Research in Financial Economics in its series Working Paper Series with number 2004-8.

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Date of creation: Jun 2004
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Handle: RePEc:ecl:ohidic:2004-8

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Citations

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Cited by:
  1. Kogan, Leonid & Ross, Stephen & Wang, Jiang & Westerfield, Mark, 2003. "The Price Impact and Survival of Irrational Traders," Working papers 4293-03, Massachusetts Institute of Technology (MIT), Sloan School of Management.
  2. Kathy Yuan & Emre Ozdenoren & Itay Goldstein, 2010. "Trading Frenzies and Their Impact on Real Investment," 2010 Meeting Papers 94, Society for Economic Dynamics.
  3. Leif Brandes & Katja Rost, . "Media, Limited Attention and the Propensity of Individuals to Buy Stocks," Working Papers 0098, University of Zurich, Institute for Strategy and Business Economics (ISU).
  4. Hott, Christian, 2009. "Herding behavior in asset markets," Journal of Financial Stability, Elsevier, vol. 5(1), pages 35-56, January.
  5. Crystal Lin & Hamid Rahman & Kenneth Yung, 2009. "Investor Sentiment and REIT Returns," The Journal of Real Estate Finance and Economics, Springer, vol. 39(4), pages 450-471, November.
  6. Guyot, Alexis & Lagoarde-Segot, Thomas & Neaime, Simon, 2014. "Foreign shocks and international cost of equity destabilization. Evidence from the MENA region," Emerging Markets Review, Elsevier, vol. 18(C), pages 101-122.
  7. Yipeng Yang & Allanus Tsoi, 2013. "Prospect Agents and the Feedback Effect on Price Fluctuations," Papers 1308.6759, arXiv.org, revised Jan 2014.
  8. Yin Hong, 2011. "Positive feedback trading, institutional investors and securities price fluctuation," China Finance Review International, Emerald Group Publishing, vol. 1(2), pages 120-132, April.
  9. Kyrtsou, Catherine & Malliaris, Anastasios G., 2009. "The impact of information signals on market prices when agents have non-linear trading rules," Economic Modelling, Elsevier, vol. 26(1), pages 167-176, January.
  10. Subrahmanyam, Avanidhar, 2009. "Optimal financial education," Review of Financial Economics, Elsevier, vol. 18(1), pages 1-9, January.
  11. Hott, C., 2011. "Lending behavior and real estate prices," Journal of Banking & Finance, Elsevier, vol. 35(9), pages 2429-2442, September.

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