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Irrational Financial Markets

Author

Listed:
  • Fabrice Rousseau

    (Economics,Finance and Accounting, National University of Ireland, Maynooth)

  • Laurent Germain

    (Toulouse Business School, France)

  • Fabrice Rousseau

    (Economics, National University of Ireland, Maynooth)

  • Anne Vanhems

    (Toulouse Business School, France)

Abstract

We analyze a model where irrational and rational traders exchange a risky asset with competitive market makers. Irrational traders misperceive the mean of prior information (optimistic/pessimistic bias), the variance of prior information (better/lower than average effect)and the variance of the noise in their private signal (overconfidence/underconfidence bias). When market makers are rational we obtain results identical to Kyle and Wang (1997). However if market makers are irrational, we obtain that moderately underconfident traders can outperform rational ones and that irrational market makers can fare better than rational ones. Lastly we find that extreme level of confidence implies high trading volume.

Suggested Citation

  • Fabrice Rousseau & Laurent Germain & Fabrice Rousseau & Anne Vanhems, 2008. "Irrational Financial Markets," Economics Department Working Paper Series n1870108.pdf, Department of Economics, National University of Ireland - Maynooth.
    • Handle: RePEc:may:mayecw:n1870108.pdf
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    File URL: http://repec.maynoothuniversity.ie/mayecw-files/N1870108.pdf
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    References listed on IDEAS

    as
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    Cited by:

    1. Stelios Bekiros, 2014. "Detecting nonlinear dependencies in foreign exchange markets: A multistep filtering approach," Working Papers 2014-182, Department of Research, Ipag Business School.

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