Rational Trader Risk
AbstractAllowing for a richer information structure than usual, we show that rational traders’ calculation with short-term price fluctuations may heavily influence their behaviour even if the interim price is not influenced by non-rational agents i.e. there is no noise trader risk. Instead, traders expect that new rational entrants with different information in the interim period will drive the price against them. Consequently, rational traders in the first period will hesitate to trade on their private information or - in the extreme - will trade against their private information i.e. buy more of the risky asset when they consider it worse. In the first part we develop a microstructure model with learning where the above effect will result in severe inefficiency and mispricing. In the second part, we discuss the critical properties of the information structure which are expected to result in similar findings in general models.
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Bibliographic InfoPaper provided by Financial Markets Group in its series FMG Discussion Papers with number dp533.
Date of creation: Apr 2005
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Other versions of this item:
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
- D4 - Microeconomics - - Market Structure and Pricing
- D8 - Microeconomics - - Information, Knowledge, and Uncertainty
- G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
This paper has been announced in the following NEP Reports:
- NEP-ALL-2005-04-16 (All new papers)
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